<PAGE> 1
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED: DECEMBER 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________ to ______________
COMMISSION FILE NUMBER: 1-8896
CAPSTEAD MORTGAGE CORPORATION
(Exact name of Registrant as specified in its Charter)
MARYLAND 75-2027937
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
8401 N CENTRAL EXPRESSWAY, SUITE 800, DALLAS, TX 75225
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (214) 874-2323
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
<TABLE>
<CAPTION>
TITLE OF EACH CLASS NAME OF EXCHANGE ON WHICH REGISTERED
------------------- ------------------------------------
<S> <C>
Common Stock ($0.01 par value) New York Stock Exchange
$1.60 Cumulative Preferred Stock, Series A ($0.10 par value) New York Stock Exchange
$1.26 Cumulative Convertible Preferred Stock, Series B ($0.10 par value) New York Stock Exchange
</TABLE>
Indicate by check mark whether the Registrant (1) has filed all documents and
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
Regulation S-K is not contained herein, and will not be contained, to the best
of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K: [ ]
AT MARCH 13, 2000 THE AGGREGATE MARKET VALUE OF THE VOTING STOCK HELD BY
NONAFFILIATES WAS $163,781,520.
NUMBER OF SHARES OF COMMON STOCK OUTSTANDING AT MARCH 13, 2000: 45,718,821
DOCUMENTS INCORPORATED BY REFERENCE:
(1) PORTIONS OF THE REGISTRANT'S ANNUAL REPORT TO STOCKHOLDERS FOR THE YEAR
ENDED DECEMBER 31, 1999 ARE INCORPORATED BY REFERENCE INTO PARTS II AND IV.
(2) PORTIONS OF THE REGISTRANT'S DEFINITIVE PROXY STATEMENT, ISSUED IN
CONNECTION WITH THE 2000 ANNUAL MEETING OF STOCKHOLDERS OF THE REGISTRANT,
ARE INCORPORATED BY REFERENCE INTO PART III.
================================================================================
<PAGE> 2
CAPSTEAD MORTGAGE CORPORATION
1999 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PART I
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
ITEM 1. BUSINESS................................................... 1
ITEM 2. PROPERTIES................................................. 3
ITEM 3. LEGAL PROCEEDINGS.......................................... 3
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS........ 3
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS......................... 3
ITEM 6. SELECTED FINANCIAL DATA.................................... 3
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS..................... 4
ITEM 7.a. QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK....................................... 4
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA................ 4
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE..................... 4
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT......... 4
ITEM 11. EXECUTIVE COMPENSATION..................................... 4
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT................................... 4
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS............. 4
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND
REPORTS ON FORM 8-K..................................... 5
</TABLE>
<PAGE> 3
PART I
ITEM 1. BUSINESS.
Capstead Mortgage Corporation ("CMC" or the "Company") was incorporated on April
15, 1985 in Maryland and commenced operations in September 1985. The Company's
business plan is to build a mortgage investment firm, earning income from
investing in mortgage assets on a leveraged basis and other investment
strategies.
Initially, the Company structured and managed residential mortgage investments.
From 1992 through 1998 the Company also operated a residential mortgage
servicing operation that was sold in December 1998. During 1999 the Company's
primary focus consisted of managing a portfolio of single-family residential
mortgage-backed securities issued by government-sponsored entities, either
Fannie Mae, Freddie Mac or Ginnie Mae ("Agency Securities").
The Company is considering modifying its investment strategy to replace a
portion of its existing mortgage investments with a diversified portfolio of
credit-sensitive commercial mortgage-backed securities ("CMBS") and residential
mortgage-backed securities, most of which are expected to be "investment grade"
at the time of purchase as determined by national rating agencies.
Credit-sensitive mortgage securities generally earn higher yields than those
typically earned on the Company's existing mortgage assets, due largely to a
higher risk of default by the underlying borrowers and, to a lesser extent,
reduced liquidity. Fully implementing this proposed modification of investment
strategy could necessitate a repositioning of the Company's existing portfolio
of mortgage securities, which could result in the recognition in operating
results of a portion of the unrealized losses on these securities that are
currently reflected in the balance sheet.
For further discussion of the Company's business, see the Registrant's Annual
Report to Stockholders for the year ended December 31, 1999 on pages 33 through
39.
EFFECTS OF INTEREST RATE CHANGES AND INTEREST RATE SENSITIVITY
For discussion of effects of interest rate changes on the Company's mortgage
securities portfolios, see the Registrant's Annual Report to Stockholders for
the year ended December 31, 1999 on pages 43 through 45.
RISKS ASSOCIATED WITH CREDIT-SENSITIVE INVESTMENTS
For discussion of risks associated with credit-sensitive investments, see the
Registrant's Annual Report to Stockholders for the year ended December 31, 1999
on pages 45 through 46.
OTHER INVESTMENT STRATEGIES
The Company may enter into other short- or long-term investment strategies as
the opportunities arise.
COMPETITION
In purchasing mortgage securities, the Company competes with savings banks,
commercial banks, mortgage and investment bankers, conduits, insurance
companies, other lenders and mutual funds.
REGULATION AND RELATED MATTERS
Prior to its sale December 31, 1998, the Company's mortgage banking operations
were subject to the rules and regulations of Fannie Mae and Freddie Mac with
respect to servicing and originating mortgage
1
<PAGE> 4
loans. In addition, there are other federal and state statutes and regulations
affecting such activities. Many of the these regulatory requirements are
designed to protect the interests of consumers, while others protect the owners
or insurers of mortgage loans. Failure to have complied with these requirements
could lead to demands for indemnification or loan repurchases from the buyers of
the mortgage banking operations or Fannie Mae or Freddie Mac, class action
lawsuits and administrative enforcement actions.
EMPLOYEES
As of December 31, 1999, the Company had 19 full-time employees.
TAX STATUS
As used herein, "Capstead REIT" refers to CMC and the entities that are
consolidated with CMC for federal income tax purposes. Capstead REIT has elected
to be taxed as a REIT for federal income tax purposes and intends to continue to
do so. As a result of this election, Capstead REIT will not be taxed at the
corporate level on taxable income distributed to stockholders, provided that
certain requirements concerning the nature and composition of its income and
assets are met and that at least 95 percent of its REIT taxable income is
distributed.
If Capstead REIT fails to qualify as a REIT in any taxable year, it would be
subject to federal income tax at regular corporate rates and would not receive a
deduction for dividends paid to stockholders. If this were the case, the amount
of after-tax earnings available for distribution to stockholders would decrease
substantially.
As long as Capstead REIT qualifies as a REIT, it will generally be taxable only
on its undistributed taxable income. Distributions out of current or accumulated
earnings and profits will be taxed to stockholders as ordinary income or capital
gain, as the case may be. Distributions in excess of the Company's accumulated
and current earnings and profits will constitute a non-taxable return of capital
to the stockholders (except insofar as such distributions exceed the cost basis
of the shares of stock) resulting in a corresponding reduction in the cost basis
of the shares of stock. The Company notifies its stockholders of the proportion
of distributions made during the taxable year that constitutes ordinary income,
return of capital or capital gains.
For 1999, 100 percent of the common and preferred stock distributions were
characterized as ordinary income; no distributions were characterized as capital
gains due to the utilization of capital loss carryforwards. Capstead REIT
realized substantial capital losses on the sale of mortgage assets in 1998. The
resulting capital loss carryforwards will in all likelihood eliminate the
potential for capital gain distributions through the year 2004 when these
carryforwards expire. During 1998, 92.0 percent and 8.0 percent of the common
stock distributions were characterized as ordinary income and nontaxable return
of capital, respectively, while 100 percent of the preferred stock distributions
were characterized as ordinary income. For 1997, capital gains were classified
as medium-term on sold assets that were held 12 to 18 months, and long-term on
sold assets that were held longer than 18 months. During 1997, 83.7 percent, 7.5
percent, 7.4 percent and 1.4 percent of the common stock distributions were
characterized as ordinary income; no distributions were characterized as capital
gains due to the utilization of capital loss carryforwards. Capstead REIT
realized substantial capital losses on the sale of mortgage assets in 1998. The
resulting capital loss carryforwards will in all likelihood eliminate the
potential for capital gain distributions through the year 2004 when these
carryforwards expire. During 1998, 92.0 percent and 8.0 percent of the common
stock distributions were characterized as ordinary income and nontaxable return
of capital, respectively, while 100 percent of the preferred stock distributions
were characterized as ordinary income. For 1997, capital gains were classified
as medium-term on sold assets that were held 12 to 18 months, and long-term on
sold assets that were held longer than 18 months. During 1997, 83.7 percent, 7.5
percent, 7.4 percent and 1.4 percent of the common stock distributions were
characterized as ordinary income, nontaxable return of capital, medium-term
capital gain and long-term capital gain, respectively, while 100 percent of the
preferred stock distributions were characterized as ordinary income.
Distributions by the Company will not normally be eligible for the dividends
received deduction for corporations. Should the Company incur losses,
stockholders will not be entitled to include such losses in their individual
income tax returns.
All taxable income of Capstead Holdings, Inc., and its primary subsidiary
Capstead Inc. (which held the mortgage banking operations prior to their sale in
December 1998), is subject to federal and state income taxes, where applicable.
Capstead REIT's taxable income will include earnings of these subsidiaries only
upon payment to Capstead REIT by distribution of such earnings, and only if
these distributions are made out of current earnings and profits.
2
<PAGE> 5
The foregoing is general in character. Reference should be made to pertinent
Internal Revenue Code sections and the Regulations issued thereunder for a
comprehensive statement of applicable federal income tax consequences.
ITEM 2. PROPERTIES.
The Company's operations are conducted in Dallas, Texas on properties leased by
the Company.
ITEM 3. LEGAL PROCEEDINGS.
Between July 23, 1998 and November 11, 1998, twenty-four purported class action
lawsuits were filed against the Company and certain of its senior officers which
allege, among other things, that the defendants violated federal securities laws
by publicly issuing false and misleading statements and omitting disclosure of
material adverse information regarding the Company's business during various
periods between January 28, 1997 and July 24, 1998. The complaints claim that as
a result of such alleged improper actions, the market price of the Company's
equity securities were artificially inflated during that time period. The
complaints seek monetary damages in an undetermined amount. In March 1999 these
actions were consolidated. The time by which the Company is to respond has not
yet run. The Company believes it has meritorious defenses to the claims and
intends to vigorously defend the actions.
All of the lawsuits are pending in the United States District Court for the
Northern District of Texas. In 23 of the lawsuits, the individual defendants
were Ronn K. Lytle, Christopher T. Gilson, Julie A. Moore, Andrew F. Jacobs and
William H. Rudluff. In one of the lawsuits, the individual defendants included
only Messrs. Lytle and Jacobs and Ms. Moore.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The information required by this item regarding the December 1999 issuance of
preferred shares in an unregistered private placement to Fortress pursuant to
Section 4(2) of the Securities Act of 1933 is included in the Registrant's
Annual Report to Stockholders for the year ended December 31, 1999 on page 25
under the caption "Note 10 - Stockholders' Equity and Preferred Stock Subject to
Repurchase," and page 36 under the caption "Investment by Fortress and Potential
Changes in Management," and is incorporated herein by reference, pursuant to
General Instruction G(2).
The information required by this item regarding the market price of, dividends
on, and number of holders of the Registrant's common shares is included in the
Registrant's Annual Report to Stockholders for the year ended December 31, 1999
on page 31 under the caption "Note 15 - Market and Dividend Information," and is
incorporated herein by reference, pursuant to General Instruction G(2).
ITEM 6. SELECTED FINANCIAL DATA.
The information required by this item is included in the Registrant's Annual
Report to Stockholders for the year ended December 31, 1999 on page 32 under the
caption "Selected Financial Data," and is incorporated herein by reference,
pursuant to General Instruction G(2).
3
<PAGE> 6
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
The information required by this item is included in the Registrant's Annual
Report to Stockholders for the year ended December 31, 1999 on pages 33 through
47 under the caption "Management's Discussion and Analysis of Financial
Condition and Results of Operations," and is incorporated herein by reference,
pursuant to General Instruction G(2).
ITEM 7.a. QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISKS.
The information required by this item is included in the Registrant's Annual
Report to Stockholders for the year ended December 31, 1999 on pages 33 through
47 under the caption "Management's Discussion and Analysis of Financial
Condition and Results of Operations," and is incorporated herein by reference,
pursuant to General Instruction G(2).
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The information required by this item is included in the Registrant's Annual
Report to Stockholders for the year ended December 31, 1999 on pages 7 through
31, and is incorporated herein by reference, pursuant to General Instruction
G(2).
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required by this item is included in the Registrant's 2000
definitive Proxy Statement on pages 4 through 18 under the captions "Election of
Directors" and "Management," which is incorporated herein by reference pursuant
to General Instruction G(3).
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this item is included in the Registrant's 2000
definitive Proxy Statement on pages 19 through 22 under the captions
"Compensation Committee Report on Executive Compensation" and "Performance
Graph," and pages 25 and 26 under the caption "Executive Compensation," all of
which are incorporated herein by reference pursuant to General Instruction G(3).
ITEM 12. SECURITY OWNERSHIP OF MANAGEMENT AND CERTAIN BENEFICIAL OWNERS.
The information required by this item is included in the Registrant's 2000
definitive Proxy Statement on pages 23 and 24 under the caption "Security
Ownership of Management and Certain Beneficial Owners," which is incorporated
herein by reference pursuant to General Instruction G(3).
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
None.
4
<PAGE> 7
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) Documents filed as part of this report:
1. The following consolidated financial statements of the Company,
included in the 1999 Annual Report to Stockholders, are incorporated
herein by reference:
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Consolidated Statement of Operations -
Three Years Ended December 31, 1999................................. *
Consolidated Balance Sheet - December 31, 1999 and 1998............... *
Consolidated Statement of Stockholders' Equity and Preferred Stock
Subject to Repurchase - Three Years Ended December 31, 1999......... *
Consolidated Statement of Cash Flows -
Three Years Ended December 31, 1999................................. *
Notes to Consolidated Financial Statements - December 31, 1999........ *
</TABLE>
2. Financial Statement Schedules - All schedules for which provision is
made in the applicable accounting regulation of the Securities and
Exchange Commission are not required under the related instructions or
are inapplicable, and therefore have been omitted.
* Incorporated herein by reference from the Company's Annual Report to
Stockholders for the year ended December 31, 1999.
3. Exhibits:
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
-------
<S> <C>
1.3 Sales Agency Agreement dated as of December 6, 1995 between
Capstead Mortgage Corporation and PaineWebber Incorporated
(the "Sales Agency Agreement")(6)
1.4 Amendment No. 1 to the Sales Agency Agreement dated as of
September 10, 1996 between Capstead Mortgage Corporation and
PaineWebber Incorporated (the "Common Stock Sales Agency
Agreement")(8)
1.5 Sales Agency Agreement dated as of August 17, 1996 Capstead
Mortgage Corporation and PaineWebber Incorporated (the "Series
B Preferred Stock 1996 Sales Agency Agreement")(8)
1.6 The Second Amendment dated as of March 4, 1997 to the Sales
Agency Agreement dated as of December 6, 1995 between the
Company and PaineWebber Incorporated (the "Common Stock Sales
Agency Agreement")(9)
1.7 The First Amendment dated as of March 4, 1997 to the Sales
Agency Agreement dated as of September 17, 1996 between the
Company and PaineWebber Incorporated (the "Series B Preferred
Stock 1996 Sales Agency Agreement")(9)
1.8 The Third Amendment dated as of November 17, 1997 to the Sales
Agency Agreement dated as of December 6, 1995 between the
Company and PaineWebber Incorporated (the "Sales Agency
Agreement")(11)
2.1 Asset Purchase Agreement dated as of December 10, 1998 by and
among Capstead Mortgage Corporation, Capstead Holdings, Inc.
and Capstead Inc. and Homecomings Financial Network, Inc.(12)
</TABLE>
5
<PAGE> 8
PART IV
ITEM 14. -- CONTINUED
3. Exhibits (continued):
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
-------
<S> <C>
3.1(a) Charter of the Company, which includes Articles of
Incorporation, Articles Supplementary for $1.60 Cumulative
Preferred Stock, Series A, and all other amendments to such
Articles of Incorporation(4)
3.1(b) Articles Supplementary ($1.26 Cumulative Convertible Preferred
Stock, Series B)(3)
3.1(c) Articles Supplementary ($0.56 Cumulative Convertible Preferred
Stock, Series C)(13)
3.1(d) Articles Supplementary ($0.40 Cumulative Convertible Preferred
Stock, Series D)(13)
3.2 Bylaws of the Company, as amended(4)
10.21 1990 Employee Stock Option Plan(1)
10.22 1990 Directors' Stock Option Plan(2)
10.23 Employment Agreement dated August 1, 1992 between Capstead
Mortgage Corporation and Ronn K. Lytle(3)
10.24 Restricted Stock Grant Agreement dated August 1, 1992 between
Capstead Mortgage Corporation and Ronn K. Lytle(3)
10.25 1994 Flexible Long Term Incentive Plan(5)
10.26 1994 Capstead Inc. Restricted Stock Plan(5)
10.27 Capstead Mortgage Corporation Deferred Compensation Plan(5)
10.28 Summary of Employment Agreement dated December 9, 1993 between
Capstead Mortgage Corporation and Christopher T. Gilson(5)
10.29 Capstead Mortgage Corporation Incentive Bonus Plan(7)
10.30 Amendment to the 1994 Flexible Long Term Incentive Plan(7)
10.31 Amendment No. 1 dated March 31, 1997 to the Employment
Agreement dated August 1, 1992 between the Company and Ronn K.
Lytle(10)
10.32 1997 Flexible Long Term Incentive Plan(10)
10.33 Purchase and Sale Agreement dated as of November 30, 1998 by
and among Capstead Inc. and GMAC Mortgage Corporation(12)
10.34 Series C and Series D Convertible Preferred Stock Purchase
Agreement dated as of December 9, 1999 by and among Capstead
Mortgage Corporation and Fortress Investment Corp(13)
10.35 Supplemental Agreement dated as of December 9, 1999 by and
among Capstead Mortgage Corporation and Fortress Investment
Corp(13)
10.36 Registration Rights Agreement dated as of December 9, 1999 by
and among Capstead Mortgage Corporation and Fortress
Investment Corp(13)
10.37 Form of Amendment No. 1 dated as of January 21, 2000 to the
Supplemental Agreement to the Stock Purchase Agreement by and
among Capstead Mortgage Corporation and Fortress Cap LLC(14)
11 Computation of per share earnings*
12 Computation of ratio of earnings to combined fixed charges and
preferred stock dividends*
13 Portions of the Company's Annual Report to Stockholders for
the year ended December 31, 1999*
21 List of subsidiaries of the Company*
23 Consent of Ernst & Young LLP, Independent Auditors*
27 Financial Data Schedule (electronic filing only)*
</TABLE>
6
<PAGE> 9
PART IV
ITEM 14. -- CONTINUED
3. Exhibits (continued):
(1) Incorporated by reference to the Company's Registration
Statement on Form S-8 (No. 33-40016) dated April 29, 1991
(2) Incorporated by reference to the Company's Registration
Statement on Form S-8 (No. 33-40017) dated April 29, 1991
(3) Incorporated by reference to the Company's Annual Report on
Form 10-K for the year ended December 31, 1992
(4) Incorporated by reference to the Company's Registration
Statement on Form S-3 (No. 33-62212) dated May 6, 1993
(5) Incorporated by reference to the Company's Annual Report on
Form 10-K for the year ended December 31, 1994
(6) Incorporated by reference to the Company's Current Report of
Form 8-K dated December 6, 1995
(7) Incorporated by reference to the Company's 10-Q for the
quarterly period ended March 31, 1996
(8) Incorporated by reference to the Company's Current Report of
Form 8-K dated August 20, 1996
(9) Incorporated by reference to the Company's Current Report of
Form 8-K dated March 26, 1997
(10) Incorporated by reference to the Company's 10-Q for the
quarterly period ended March 31, 1997
(11) Incorporated by reference to the Company's Current Report of
Form 8-K dated December 23, 1997
(12) Incorporated by reference to the Company's Current Report of
Form 8-K dated December 31, 1998
(13) Incorporated by reference to the Company's Current Report of
Form 8-K dated December 15, 1999
(14) Incorporated by reference to the Company's Current Report of
Form 8-K dated February 2, 2000
* Filed herewith
(b) Reports on Form 8-K:
Current Report on Form 8-K dated December 15, 1999 to file the
following:
Exhibit 3.1(c) - Articles Supplementary $0.56 Cumulative Convertible
Preferred Stock, Series C.
Exhibit 3.1(d) - Articles Supplementary $0.40 Cumulative Convertible
Preferred Stock, Series D.
Exhibit 10.34 - Series C and Series D Convertible Preferred Stock Asset
Purchase Agreement dated as of December 9, 1999 by and among Capstead
Mortgage Corporation and Fortress Investment Corp.
Exhibit 10.35 - Supplemental Agreement dated as of December 9, 1999 by
and among Capstead Mortgage Corporation and Fortress Investment Corp.
Exhibit 10.36 - Registration Rights Agreement dated as of December 9,
1999 by and among Capstead Mortgage Corporation and Fortress Investment
Corp.
Current Report on Form 8-K dated February 2, 2000 to file the
following:
Exhibit 10.37 - Form of Amendment No. 1 dated as of January 21, 2000 to
the Supplemental Agreement to the Stock Purchase Agreement by and among
Capstead Mortgage Corporation and Fortress Cap LLC.
(c) Exhibits - The response to this section of ITEM 14 is submitted as a
separate section of this report.
(d) Financial Statement Schedules - The response to this section of ITEM 14
is submitted as a separate section of this report.
7
<PAGE> 10
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Company has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
CAPSTEAD MORTGAGE CORPORATION
REGISTRANT
Date: March 8, 2000 By: /s/ ANDREW F. JACOBS
------------------------------------
Andrew F. Jacobs
Executive Vice President - Finance
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities indicated below and on the dates indicated.
/s/ RONN K. LYTLE Chairman, Chief Executive March 8, 2000
- --------------------------- Officer and Director
(Ronn K. Lytle)
/s/ ANDREW F. JACOBS Executive Vice President - March 8, 2000
- --------------------------- Finance
(Andrew F. Jacobs)
/s/ WESLEY R. EDENS Director March 10, 2000
- ---------------------------
(Wesley R. Edens)
/s/ ROBERT I. KAUFFMAN Director March 9, 2000
- ---------------------------
(Robert I. Kauffman)
/s/ BEVIS LONGSTRETH Director March 9, 2000
- ---------------------------
(Bevis Longstreth)
/s/ PAUL M. LOW Director March 9, 2000
- ---------------------------
(Paul M. Low)
/s/ HARRIET E. MIERS Director March 9, 2000
- ---------------------------
(Harriet E. Miers)
/s/ WILLIAM R. SMITH Director March 9, 2000
- ---------------------------
(William R. Smith)
/s/ JOHN C. TOLLESON Director March 9, 2000
- ---------------------------
(John C. Tolleson)
8
<PAGE> 11
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C>
1.3 Sales Agency Agreement dated as of December 6, 1995 between
Capstead Mortgage Corporation and PaineWebber Incorporated
(the "Sales Agency Agreement")(6)
1.4 Amendment No. 1 to the Sales Agency Agreement dated as of
September 10, 1996 between Capstead Mortgage Corporation and
PaineWebber Incorporated (the "Common Stock Sales Agency
Agreement")(8)
1.5 Sales Agency Agreement dated as of August 17, 1996 Capstead
Mortgage Corporation and PaineWebber Incorporated (the "Series
B Preferred Stock 1996 Sales Agency Agreement")(8)
1.6 The Second Amendment dated as of March 4, 1997 to the Sales
Agency Agreement dated as of December 6, 1995 between the
Company and PaineWebber Incorporated (the "Common Stock Sales
Agency Agreement")(9)
1.7 The First Amendment dated as of March 4, 1997 to the Sales
Agency Agreement dated as of September 17, 1996 between the
Company and PaineWebber Incorporated (the "Series B Preferred
Stock 1996 Sales Agency Agreement")(9)
1.8 The Third Amendment dated as of November 17, 1997 to the Sales
Agency Agreement dated as of December 6, 1995 between the
Company and PaineWebber Incorporated (the "Sales Agency
Agreement")(11)
2.1 Asset Purchase Agreement dated as of December 10, 1998 by and
among Capstead Mortgage Corporation, Capstead Holdings, Inc.
and Capstead Inc. and Homecomings Financial Network, Inc.(12)
3.1(a) Charter of the Company, which includes Articles of
Incorporation, Articles Supplementary for $1.60 Cumulative
Preferred Stock, Series A, and all other amendments to such
Articles of Incorporation(4)
3.1(b) Articles Supplementary ($1.26 Cumulative Convertible Preferred
Stock, Series B)(3)
3.1(c) Articles Supplementary ($0.56 Cumulative Convertible Preferred
Stock, Series C)(13)
3.1(d) Articles Supplementary ($0.40 Cumulative Convertible Preferred
Stock, Series D)(13)
3.2 Bylaws of the Company, as amended(4)
10.21 1990 Employee Stock Option Plan(1)
10.22 1990 Directors' Stock Option Plan(2)
10.23 Employment Agreement dated August 1, 1992 between Capstead
Mortgage Corporation and Ronn K. Lytle(3)
10.24 Restricted Stock Grant Agreement dated August 1, 1992 between
Capstead Mortgage Corporation and Ronn K. Lytle(3)
10.25 1994 Flexible Long Term Incentive Plan(5)
10.26 1994 Capstead Inc. Restricted Stock Plan(5)
10.27 Capstead Mortgage Corporation Deferred Compensation Plan(5)
10.28 Summary of Employment Agreement dated December 9, 1993 between
Capstead Mortgage Corporation and Christopher T. Gilson(5)
10.29 Capstead Mortgage Corporation Incentive Bonus Plan(7)
10.30 Amendment to the 1994 Flexible Long Term Incentive Plan(7)
10.31 Amendment No. 1 dated March 31, 1997 to the Employment
Agreement dated August 1, 1992 between the Company and Ronn K.
Lytle(10)
10.32 1997 Flexible Long Term Incentive Plan(10)
</TABLE>
<PAGE> 12
INDEX TO EXHIBITS
(continued)
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C>
10.33 Purchase and Sale Agreement dated as of November 30, 1998 by
and among Capstead Inc. and GMAC Mortgage Corporation(12)
10.34 Series C and Series D Convertible Preferred Stock Purchase
Agreement dated as of December 9, 1999 by and among Capstead
Mortgage Corporation and Fortress Investment Corp(13)
10.35 Supplemental Agreement dated as of December 9, 1999 by and
among Capstead Mortgage Corporation and Fortress Investment
Corp(13)
10.36 Registration Rights Agreement dated as of December 9, 1999 by
and among Capstead Mortgage Corporation and Fortress
Investment Corp(13)
10.37 Form of Amendment No. 1 dated as of January 21, 2000 to the
Supplemental Agreement to the Stock Purchase Agreement by and
among Capstead Mortgage Corporation and Fortress Cap LLC(14)
11 Computation of per share earnings*
12 Computation of ratio of earnings to combined fixed charges and
preferred stock dividends*
13 Portions of the Company's Annual Report to Stockholders for
the year ended December 31, 1999*
21 List of subsidiaries of the Company*
23 Consent of Ernst & Young LLP, Independent Auditors*
27 Financial Data Schedule (electronic filing only)*
</TABLE>
(1) Incorporated by reference to the Company's Registration
Statement on Form S-8 (No. 33-40016) dated April 29, 1991
(2) Incorporated by reference to the Company's Registration
Statement on Form S-8 (No. 33-40017) dated April 29, 1991
(3) Incorporated by reference to the Company's Annual Report on
Form 10-K for the year ended December 31, 1992
(4) Incorporated by reference to the Company's Registration
Statement on Form S-3 (No. 33-62212) dated May 6, 1993
(5) Incorporated by reference to the Company's Annual Report on
Form 10-K for the year ended December 31, 1994
(6) Incorporated by reference to the Company's Current Report of
Form 8-K dated December 6, 1995
(7) Incorporated by reference to the Company's 10-Q for the
quarterly period ended March 31, 1996
(8) Incorporated by reference to the Company's Current Report of
Form 8-K dated August 20, 1996
(9) Incorporated by reference to the Company's Current Report of
Form 8-K dated March 26, 1997
(10) Incorporated by reference to the Company's 10-Q for the
quarterly period ended March 31, 1997
(11) Incorporated by reference to the Company's Current Report of
Form 8-K dated December 23, 1997
(12) Incorporated by reference to the Company's Current Report of
Form 8-K dated December 31, 1998
(13) Incorporated by reference to the Company's Current Report of
Form 8-K dated December 15, 1999
(14) Incorporated by reference to the Company's Current Report of
Form 8-K dated February 2, 2000
* Filed herewith
<PAGE> 1
EXHIBIT 11
CAPSTEAD MORTGAGE CORPORATION
COMPUTATION OF NET INCOME PER SHARE
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
BASIC:
Average number of common shares outstanding 58,348 60,948 51,257
--------- --------- ---------
Net income (loss) $ 57,909 $(234,764) $ 159,926
Less cash dividends paid on convertible
preferred shares:
Series A ($1.60 paid per share) (598) (610) (683)
Series B ($1.26 paid per share) (21,391) (21,732) (24,774)
Series C ($0.03 paid per share) (185) -- --
Series D ($0.02 paid per share) (131) -- --
Repurchase price in excess of recorded value (251) -- --
--------- --------- ---------
Net income available to common stockholders $ 35,353 $(257,106) $ 134,469
--------- --------- ---------
Basic net income (loss) per common share $ 0.61 $ (4.22) $ 2.62
--------- --------- ---------
DILUTED:*
Average number of common shares outstanding 58,348 60,948 51,257
Assumed conversion of dilutive convertible
preferred shares:
Series A -- -- 889
Series B -- -- 14,776
Series C 339 -- --
Series D 339 -- --
Incremental shares calculated using the
treasury stock method 20 -- 1,101
59,046 60,948 68,023
--------- --------- ---------
Net income (loss) $ 57,909 $(234,764) $ 159,926
Less cash dividends paid on antidilutive
convertible preferred shares:
Series A ($1.60 paid per share) (598) (610) --
Series B ($1.26 paid per share) (21,391) (21,732) --
Repurchase price in excess of recorded value (251) -- --
--------- --------- ---------
Net income available to common stockholders $ 35,669 $(257,106) $ 159,926
--------- --------- ---------
Diluted net income (loss) per common share $ 0.60 $ (4.22) $ 2.35
--------- --------- ---------
</TABLE>
* The Series A and B shares were not considered convertible for purposes
of calculating diluted net income (loss) per common share in 1999 and
1998 because the effects of conversion were antidilutive. The Series C
and D shares were issued in December 1999.
<PAGE> 1
EXHIBIT 12
CAPSTEAD MORTGAGE CORPORATION
COMPUTATION OF RATIO OF EARNINGS TO COMBINED
FIXED CHARGES AND PREFERRED STOCK DIVIDENDS
(IN THOUSANDS, EXCEPT RATIOS)
(UNAUDITED)
(a) Computation of ratio of earnings to combined fixed charges and
preferred stock dividends (including CMO debt):
<TABLE>
<CAPTION>
Year Ended December 31
------------------------------------------------------------------
1999 1998 1997 1996 1995
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Fixed charges $ 502,933 $ 673,233 $ 633,845 $ 598,312 $ 584,137
Preferred stock dividends 22,556 22,342 25,457 36,356 39,334
--------- --------- --------- --------- ---------
Combined fixed charges and
preferred stock dividends 525,489 695,575 659,302 634,668 623,471
Net income (loss) 57,909 (234,764) 159,926 127,228 77,359
--------- --------- --------- --------- ---------
Total $ 583,398 $ 460,811 $ 819,228 $ 761,896 $ 700,830
--------- --------- --------- --------- ---------
Ratio of earnings to combined
fixed charges and preferred
stock dividends 1.11:1 0.66:1 1.24:1 1.20:1 1.12:1
--------- --------- --------- --------- ---------
</TABLE>
(b) Computation of ratio of earnings to combined fixed charges and
preferred stock dividends (excluding CMO debt):
<TABLE>
<CAPTION>
Year Ended December 31
------------------------------------------------------------------
1999 1998 1997 1996 1995
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Fixed charges $ 232,852 $ 332,985 $ 352,348 $ 283,974 $ 223,751
Preferred stock dividends 22,556 22,342 25,457 36,356 39,334
--------- --------- --------- --------- ---------
Combined fixed charges and
preferred stock dividends 255,408 355,327 377,805 320,330 263,085
Net income (loss) 57,909 (234,764) 159,926 127,228 77,359
--------- --------- --------- --------- ---------
Total $ 313,317 $ 120,563 $ 537,731 $ 447,558 $ 340,444
--------- --------- --------- --------- ---------
Ratio of earnings to combined
fixed charges and preferred
stock dividends 1.23:1 0.34:1 1.42:1 1.40:1 1.29:1
--------- --------- --------- --------- ---------
</TABLE>
<PAGE> 1
EXHIBIT 13
CAPSTEAD MORTGAGE CORPORATION
PORTIONS OF THE
ANNUAL REPORT TO STOCKHOLDERS
FOR THE YEAR ENDED DECEMBER 31, 1999
<PAGE> 2
EXHIBIT 13
CAPSTEAD MORTGAGE CORPORATION
REPORT OF INDEPENDENT AUDITORS
Stockholders and Board of Directors
Capstead Mortgage Corporation
We have audited the accompanying consolidated balance sheet of Capstead
Mortgage Corporation and subsidiaries as of December 31, 1999 and 1998, and the
related consolidated statements of operations, stockholders' equity and
preferred stock subject to repurchase, and cash flows for each of the three
years in the period ended December 31, 1999. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Capstead
Mortgage Corporation and subsidiaries at December 31, 1999 and 1998, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1999, in conformity with accounting
principles generally accepted in the United States.
By: /s/ ERNST & YOUNG LLP
Dallas, Texas
January 27, 2000
7
<PAGE> 3
CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED STATEMENT OF OPERATIONS
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
Year Ended December 31
--------------------------------------------
1999 1998 1997
---------- ---------- ----------
<S> <C> <C> <C>
INTEREST INCOME:
Mortgage securities and other investments $ 293,841 $ 311,807 $ 339,980
CMO collateral and investments 269,318 355,391 354,279
---------- ---------- ----------
Total interest income 563,159 667,198 694,259
========== ========== ==========
INTEREST AND RELATED EXPENSE:
Short-term borrowings:
Mortgage securities and other investments 232,852 291,125 300,391
CMO investments -- 22,733 29,244
Collateralized mortgage obligations 270,081 340,248 281,497
Mortgage insurance and other 2,014 5,469 5,155
---------- ---------- ----------
Total interest and related expense 504,947 659,575 616,287
---------- ---------- ----------
Net margin on mortgage assets and other investments 58,212 7,623 77,972
---------- ---------- ----------
NET MARGIN ON MORTGAGE BANKING OPERATIONS -- 11,821 59,422
---------- ---------- ----------
OTHER OPERATING REVENUE (EXPENSE):
Gain (loss) on sale of mortgage assets and related derivative
financial instruments 1,738 (245,261) 27,737
Impairment on CMO investments -- (4,051) --
CMO administration and other 4,083 4,598 4,000
Other operating expense (6,124) (9,494) (9,205)
---------- ---------- ----------
Total other operating revenue (expense) (303) (254,208) 22,532
---------- ---------- ----------
NET INCOME (LOSS) $ 57,909 $ (234,764) $ 159,926
========== ========== ==========
Net income (loss) $ 57,909 $ (234,764) $ 159,926
Less cash dividends on preferred stock (22,556) (22,342) (25,457)
---------- ---------- ----------
Net income (loss) available to common stockholders $ 35,353 $ (257,106) $ 134,469
========== ========== ==========
NET INCOME (LOSS) PER COMMON SHARE:
Basic $ 0.61 $ (4.22) $ 2.62
Diluted 0.60 (4.22) 2.35
AVERAGE NUMBER OF COMMON SHARES OUTSTANDING:
Basic 58,348 60,948 51,257
Diluted 59,046 60,948 68,023
</TABLE>
See accompanying notes to consolidated financial statements.
8
<PAGE> 4
CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED BALANCE SHEET
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
December 31
-------------------------------
1999 1998
------------ ------------
<S> <C> <C>
ASSETS
Mortgage securities and other investments $ 5,408,714 $ 2,369,602
CMO collateral and investments 3,318,886 4,571,274
------------ ------------
8,727,600 6,940,876
Prepaids, receivables and other 48,451 59,526
Restricted cash and cash equivalents 2,500 26,500
Cash and cash equivalents 28,488 73,385
------------ ------------
$ 8,807,039 $ 7,100,287
============ ============
LIABILITIES
Borrowings under repurchase arrangements $ 4,872,392 $ 1,839,868
Collateralized mortgage obligations 3,289,584 4,521,324
Accounts payable and accrued expenses 30,673 58,894
------------ ------------
8,192,649 6,420,086
------------ ------------
PREFERRED STOCK SUBJECT TO REPURCHASE
$0.10 par value; 10,756 shares authorized, issued and
outstanding ($52,735 aggregate repurchase amount) 50,584 --
------------ ------------
STOCKHOLDERS' EQUITY
Preferred stock -- $0.10 par value;
89,244 shares authorized:
$1.60 Cumulative Preferred Stock, Series A,
374 and 374 shares issued and outstanding
($6,134 aggregate liquidation preference) 5,228 5,228
$1.26 Cumulative Convertible Preferred Stock, Series B,
16,673 and 17,298 shares issued and outstanding
($189,739 aggregate liquidation preference) 186,248 193,196
Common stock -- $0.01 par value; 100,000 shares authorized;
56,856 and 60,546 shares issued and outstanding 569 605
Paid-in capital 769,617 787,677
Accumulated deficit (304,568) (305,287)
Accumulated other comprehensive income (loss) (93,288) (1,218)
------------ ------------
563,806 680,201
------------ ------------
$ 8,807,039 $ 7,100,287
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
9
<PAGE> 5
CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY AND
PREFERRED STOCK SUBJECT TO REPURCHASE
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
Three Years Ended December 31, 1999
------------------------------------------------------------------------------------------
Preferred Accumulated
Stock Other Total
Subject to Preferred Common Paid-in Accumulated Comprehensive Stockholders'
Repurchase Stock Stock Capital Deficit Income (Loss) Equity
---------- ---------- ---------- ---------- ----------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE AT JANUARY 1, 1997 $ -- $ 266,396 $ 447 $ 461,045 $ 4,582 $ (5,601) $ 726,869
Comprehensive income:
Net income -- -- -- -- 159,926 -- 159,926
Other comprehensive income (loss):
Change in unrealized loss on debt
securities, net of
reclassification amount -- -- -- -- -- (46,845) (46,845)
---------
Total comprehensive income 113,081
Cash dividends:
Common ($2.40 per share) -- -- -- -- (126,375) -- (126,375)
Preferred -- -- -- -- (25,457) -- (25,457)
Conversion of preferred stock -- (85,097) 57 85,040 -- -- --
Additions to capital -- 14,199 81 186,210 -- -- 200,490
--------- --------- --------- --------- --------- --------- ---------
BALANCE AT DECEMBER 31, 1997 -- 195,498 585 732,295 12,676 (52,446) 888,608
Comprehensive loss:
Net loss -- -- -- -- (234,764) -- (234,764)
Other comprehensive income (loss):
Change in unrealized loss on debt
securities, net of
reclassification amount -- -- -- -- -- 51,228 51,228
---------
Total comprehensive loss (183,536)
Cash dividends:
Common ($1.00 per share) -- -- -- -- (60,857) -- (60,857)
Preferred -- -- -- -- (22,342) -- (22,342)
Conversion of preferred stock -- (1,111) 1 1,110 -- -- --
Additions to capital -- 4,037 29 58,366 -- -- 62,432
Capital stock repurchases -- -- (10) (4,094) -- -- (4,104)
--------- --------- --------- --------- --------- --------- ---------
BALANCE AT DECEMBER 31, 1998 -- 198,424 605 787,677 (305,287) (1,218) 680,201
Comprehensive loss:
Net income -- -- -- -- 57,909 -- 57,909
Other comprehensive income (loss):
Change in unrealized loss on debt
securities, net of
reclassification amount -- -- -- -- -- (92,070) (92,070)
---------
Total comprehensive loss (34,161)
Cash dividends:
Common ($0.60 per share) -- -- -- -- (34,634) -- (34,634)
Preferred -- -- -- -- (22,305) -- (22,305)
Additions to capital 50,584 -- -- -- -- -- --
Capital stock repurchases -- (6,948) (36) (18,060) (251) -- (25,295)
--------- --------- --------- --------- --------- --------- ---------
BALANCE AT DECEMBER 31, 1999 $ 50,584 $ 191,476 $ 569 $ 769,617 $(304,568) $ (93,288) $ 563,806
========= ========= ========= ========= ========= ========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
10
<PAGE> 6
CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------------
1999 1998 1997
------------ ------------ ------------
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income (loss) $ 57,909 $ (234,764) $ 159,926
Noncash items:
Impairment on CMO investments -- 4,051 --
Amortization and impairment of mortgage servicing rights and related costs -- 319,886 64,892
Amortization of discount and premium 40,020 134,693 114,603
Depreciation and other amortization 1,043 5,010 3,585
Gain on sale of financial instruments held to offset the effects of
impairment -- (173,424) --
Gain on sale of mortgage servicing rights and mortgage banking operations -- (2,877) --
Loss (gain) on sale of mortgage assets and derivative financial instruments (1,738) 245,261 (27,737)
Net change in prepaids, receivables, other assets, accounts
payable and accrued expenses 10,693 112,183 (26,994)
------------ ------------ ------------
Net cash provided by operating activities 107,927 410,019 288,275
------------ ------------ ------------
INVESTING ACTIVITIES:
Purchases of mortgage securities and other investments (4,380,781) (4,797,684) (4,467,187)
Purchases of CMO collateral and investments -- (1,305,865) (1,684,295)
Purchases of mortgage servicing rights -- (106,498) (139,997)
Purchases of derivative financial instruments -- (78,396) (112,417)
Principal collections on mortgage investments 1,247,027 2,112,469 1,459,956
Proceeds from sales of mortgage assets 114,763 6,924,038 2,020,450
Proceeds from sales and settlement of derivative financial instruments 12,595 239,481 34,191
Proceeds from sale of mortgage servicing rights and
mortgage banking operations -- 582,772 --
CMO collateral:
Principal collections 1,079,961 1,187,988 537,817
Decrease in accrued interest receivable 7,900 8,367 4,724
Decrease (increase) in short-term investments 14,119 721 (4,546)
------------ ------------ ------------
Net cash provided (used) by investing activities (1,904,416) 4,767,393 (2,351,304)
------------ ------------ ------------
FINANCING ACTIVITIES:
Increase (decrease) in short-term borrowings 3,032,524 (5,259,838) 1,636,850
Decrease in mortgage servicing acquisitions payable -- (8,363) (63,374)
Collateralized mortgage obligations:
Issuance of securities -- 1,494,853 1,109,411
Principal payments on securities (1,241,769) (1,299,115) (673,119)
Increase (decrease) in accrued interest payable (7,513) (11,977) 2,253
Capital stock transactions 25,289 46,235 199,214
Dividends paid (56,939) (83,199) (151,832)
------------ ------------ ------------
Net cash provided (used) by financing activities 1,751,592 (5,121,404) 2,059,403
------------ ------------ ------------
Net change in cash and cash equivalents (44,897) 56,008 (3,626)
Cash and cash equivalents at beginning of year 73,385 17,377 21,003
------------ ------------ ------------
Cash and cash equivalents at end of year $ 28,488 $ 73,385 $ 17,377
============ ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
11
<PAGE> 7
CAPSTEAD MORTGAGE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999
NOTE 1 -- BUSINESS
Capstead Mortgage Corporation, a mortgage investment firm, earns income from
investing in mortgage assets on a leveraged basis and from other investment
strategies. Declining long-term interest rates throughout much of 1998
contributed to substantial liquidity issues for the mortgage finance industry.
In response to these market conditions, during 1998 the Company reduced its
mortgage asset holdings and sold its mortgage banking operations (see NOTE 8).
As a result, the Company entered 1999 with substantial liquidity but diminished
earnings capacity. During 1999 the Company's primary focus consisted of managing
a portfolio of single-family residential mortgage-backed securities issued by
government-sponsored entities, either Fannie Mae, Freddie Mac or Ginnie Mae
("Agency Securities").
The Company is considering modifying its investment strategy to replace a
portion of its existing mortgage investments with a diversified portfolio of
credit-sensitive commercial mortgage-backed securities ("CMBS") and residential
mortgage-backed securities, most of which are expected to be "investment grade"
at the time of purchase as determined by national rating agencies.
Credit-sensitive mortgage securities generally earn higher yields than those
typically earned on the Company's existing mortgage assets, due largely to a
higher risk of default by the underlying borrowers and, to a lesser extent,
reduced liquidity. Fully implementing this proposed modification of investment
strategy could necessitate a repositioning of the Company's existing portfolio
of mortgage securities, which could result in the recognition in operating
results of a portion of the unrealized losses on these securities that are
currently reflected in the balance sheet.
NOTE 2 -- ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Capstead
Mortgage Corporation ("Capstead"), its special-purpose finance subsidiaries and
certain other entities (collectively, the "Company"). Intercompany balances and
transactions have been eliminated. Substantially all of the assets of the
special-purpose finance subsidiaries are pledged to secure collateralized
mortgage obligations ("CMOs") and are not available for the satisfaction of
general claims of Capstead. Capstead has no responsibility for CMOs beyond the
assets pledged as collateral.
USE OF ESTIMATES
The use of estimates is inherent in the preparation of financial statements
in conformity with generally accepted accounting principles. The amortization of
premiums and discounts on mortgage assets and CMOs is based on estimates of
future movements in interest rates and
12
<PAGE> 8
CAPSTEAD MORTGAGE CORPORATION
how resulting rates will affect prepayments on underlying mortgage loans. Actual
results could differ from those estimates. As was the case in 1998, prepayments
could rise to levels that could adversely affect profitability.
MORTGAGE ASSETS
Mortgage assets held in the form of mortgage-backed securities are debt
securities. Management determines the appropriate classification of debt
securities at the time of purchase and periodically reevaluates such
designation. Debt securities are classified as held-to-maturity when the Company
has the positive intent and ability to hold the securities to maturity.
Held-to-maturity securities are stated at amortized cost. Debt securities not
classified as held-to-maturity are classified as available-for-sale.
Available-for-sale securities are stated at fair value with unrealized gains
(losses) reported as a separate component of Accumulated other comprehensive
income (loss) in stockholders' equity. Mortgage loans are carried at the lower
of cost or market determined on an aggregate basis.
Interest is recorded as income when earned. Any premium or discount is
recognized as an adjustment to interest income by the interest method over the
life of the related mortgage asset. Realized gains (losses) are included in
Other operating revenue (expense). The cost of assets sold is based on the
specific identification method.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include unrestricted cash on hand and highly
liquid investments with original maturities of three months or less.
RESTRICTED CASH AND CASH EQUIVALENTS
Restricted cash and cash equivalents represents cash and highly liquid
investments held in escrow in connection with the sale of the mortgage banking
operations. Remaining funds are scheduled to be released from escrow July 1,
2000 provided no claims against these funds are made pursuant to the terms of
the related sale agreements.
MORTGAGE SERVICING RIGHTS
Prior to the December 1998 sale of the mortgage banking operations, the
cost of acquiring mortgage servicing rights was capitalized and amortized in
proportion to and over the period of estimated net servicing income. Included in
Net margin on mortgage banking operations are amortization and impairment
charges related to mortgage servicing rights. Estimated net servicing income was
evaluated periodically and adjustments were made to the rate of amortization.
Mortgage servicing rights were evaluated for impairment on a disaggregated basis
by predominant risk characteristics. A valuation allowance was established
through a charge to operating results to the extent that the recorded amount for
servicing rights within an individual stratum exceeded fair value. Fair values
were established through use of a discounted cash flow valuation model that
incorporated assumptions the Company believed market participants used in
estimating the fair value of future net servicing income including assumptions
regarding prepayment speeds, discount rates and servicing costs. For impairment
evaluation purposes, the Company stratified its servicing portfolio based on
term, interest rate and loan type (fixed-rate versus adjustable-rate).
13
<PAGE> 9
CAPSTEAD MORTGAGE CORPORATION
DERIVATIVE FINANCIAL INSTRUMENTS
The Company may acquire derivative financial instruments ("Derivatives")
for risk management purposes. Derivatives acquired from time to time may include
interest rate floors, swaps and caps, U.S. Treasury futures contracts and
options; written options on mortgage assets or various other Derivatives
available in the market place that are compatible with the Company's risk
management objectives. Owners of Derivatives have credit risk associated with
the counterparties to the instruments. The Company manages this risk by dealing
only with large, financially sound investment banking firms. Realized and
unrealized gains (losses) on Derivatives not designated as hedges are taken
directly to operating results.
Realized and unrealized gains (losses) on Derivatives designated as hedges
reduce (increase) the carrying amount of the assets hedged. Ongoing correlation
and effectiveness of such Derivatives is measured by comparing the change in
value of the hedges with the change in value of the assets hedged. Should a
hedge prove ineffective, hedge accounting would cease and the change in value of
the hedge instruments would be reflected in operating results. The cost of
acquiring Derivatives designated as hedges is reflected as a charge to operating
results as a component of the related hedged item over the contractual lives of
the instruments. The fair value of Derivatives, if any, is included in Prepaids,
receivables and other on the balance sheet.
Prior to selling nearly all of its investments in interest-only mortgage
securities and its investment in mortgage servicing rights in 1998, the Company
held Derivatives to help offset the effects of falling mortgage interest rates
on the value of these investments. Other than remaining interest rate floors
sold in January 1999, the Company did not hold any Derivatives during 1999.
In June 1998 the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"). SFAS 133 establishes new accounting and
reporting standards for Derivatives and hedging activities. It requires an
entity to recognize all Derivatives as either assets or liabilities in the
statement of financial position and to measure those instruments at fair value.
If certain conditions are met, a Derivative may be specifically designated as
(i) a hedge of the exposure to changes in the fair value of a recognized asset
or liability or an unrecognized firm commitment; (ii) a hedge of the exposure to
variable cash flows of a forecasted transaction; or (iii) in certain
circumstances, a hedge of a foreign currency exposure. This statement is
effective for the Company's fiscal year ending December 31, 2001. The adoption
of SFAS 133 is not expected to have a material impact on the financial position
or results of operations of the Company.
BORROWINGS
CMOs and borrowings under repurchase arrangements are carried at their
unpaid principal balances, net of unamortized discount or premium. Any discount
or premium is recognized as an adjustment to interest expense by the interest
method over the expected term of the related borrowings.
14
<PAGE> 10
CAPSTEAD MORTGAGE CORPORATION
NET MARGIN ON MORTGAGE BANKING OPERATIONS
Prior to the December 1998 sale of the mortgage banking operations, the
Company earned mortgage banking revenue for servicing and, to a lesser extent,
originating single-family residential mortgage loans. This revenue is included
in Net margin on mortgage banking operations offset by related costs of
servicing including amortization and impairment of mortgage servicing rights.
Mortgage banking revenue represents fees received for servicing mortgage loans,
interest earned on temporarily-held cash balances, income earned from
originating and selling mortgage loans and other ancillary income customary to
mortgage banking operations. Also included in Net margin on mortgage banking
operations in 1998 is the gain on the sale of this operation. Servicing fees
were calculated based on a contractual percentage of the outstanding monthly
principal balance of mortgage loans serviced and recognized as income when
collected. Other mortgage revenue was recorded on the accrual basis.
INCOME TAXES
Income taxes are accounted for using the liability method, and deferred
income tax assets and liabilities are determined based on differences between
financial reporting and tax bases of assets and liabilities and are measured
using enacted tax rates and laws that will be in effect when the differences are
expected to reverse.
Capstead and its qualified real estate investment trust ("REIT")
subsidiaries have elected to be taxed as a REIT and intend to continue to do so.
As a result of this election, Capstead is not taxed on taxable income
distributed to stockholders if certain REIT qualification tests are met. It is
Capstead's policy to distribute 100 percent of taxable income of the REIT within
the time limits prescribed by the Internal Revenue Code (the "Code"), which may
extend into the subsequent taxable year. Accordingly, no provision has been made
for income taxes for Capstead and its qualified REIT subsidiaries. Capstead's
non-REIT subsidiaries file a separate consolidated federal income tax return and
are subject to income taxes.
STOCK-BASED COMPENSATION
Compensation cost for stock-based awards is generally measured as the
excess, if any, of the quoted market price of the Company's stock at the date of
the grant over the amount an employee must pay to acquire the stock and is
recognized as compensation expense as the awards vest and restrictions lapse.
NET INCOME (LOSS) PER COMMON SHARE
Basic net income (loss) per common share is computed by dividing net income
(loss), after deducting preferred stock dividends, by the weighted average
number of common shares outstanding. Diluted net income (loss) per common share
is computed by dividing net income (loss) by the weighted average number of
common shares and common stock equivalents outstanding, and assuming conversion
of the $1.60 Cumulative Preferred Stock, Series A ("Series A" shares); the $1.26
Cumulative Convertible Preferred Stock, Series B ("Series B" shares); $0.56
Cumulative Convertible Preferred Stock, Series C ("Series C" shares); and $0.40
Cumulative Convertible Preferred Stock, Series D ("Series D" shares) if
15
<PAGE> 11
CAPSTEAD MORTGAGE CORPORATION
the effects of conversion are dilutive. The Series A and B shares were not
considered convertible for purposes of calculating diluted net income (loss) per
common share in 1999 and 1998 because the effects of conversion were
antidilutive.
NOTE 3 -- MORTGAGE SECURITIES AND OTHER INVESTMENTS
Mortgage securities and other investments and the related average effective
interest rates (calculated for the indicated year including mortgage insurance
costs on non-agency securities and excluding unrealized gains and losses) were
as follows (dollars in thousands):
<TABLE>
<CAPTION>
Purchase Average
Principal Premiums Carrying Average Effective
Balance (Discounts) Basis Amount Coupon Rate
------------ ------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
DECEMBER 31, 1999 * ** **
Agency Securities:
FNMA/FHLMC:
Fixed-rate $ 1,063,822 $ (2,924) $ 1,060,898 $ 1,009,577 6.18% 6.23%
Medium-term 1,123,984 4,516 1,128,500 1,103,704 6.15 5.89
ARMs:
LIBOR/CMT 911,262 20,824 932,086 935,291 7.03 5.63
COFI 242,573 1,570 244,143 237,721 5.84 5.62
GNMA ARMs 1,924,659 26,083 1,950,742 1,936,032 6.29 5.65
------------ ------------ ------------ ------------ ------------ ------------
5,266,300 50,069 5,316,369 5,222,325 6.35 5.81
Non-agency securities 126,431 385 126,816 127,059 8.34 8.06
CMBS -- adjustable-rate 60,182 (852) 59,330 59,330 7.54 8.53
------------ ------------ ------------ ------------ ------------ ------------
60,182
$ 5,452,913 $ 49,602 $ 5,502,515 $ 5,408,714 6.41% 5.87%
============ ============ ============ ============ ============ ============
DECEMBER 31, 1998
Agency and U.S. Treasury
Securities:
U.S. Treasury notes $ $ -- $ -- $ -- --% 5.40%
FNMA/FHLMC:
Fixed-rate 397,648 (731) 396,917 400,345 6.50 6.51
Medium-term 313,947 3,597 317,544 318,033 6.60 5.94
LIBOR/CMT ARMs 616,274 16,350 632,624 626,356 7.49 5.20
GNMA ARMs 871,308 14,635 885,943 883,451 6.75 5.80
------------ ------------ ------------ ------------ ------------ ------------
2,199,177 33,851 2,233,028 2,228,185 6.89 5.77
Non-agency securities 140,718 (157) 140,561 141,417 7.22 7.02
------------ ------------ ------------ ------------ ------------ ------------
$ 2,339,895 $ 33,694 $ 2,373,589 $ 2,369,602 6.91% 5.89%
============ ============ ============ ============ ============ ============
</TABLE>
* Includes mark to market, if applicable (see NOTE 7).
** Average Coupon is calculated as of the indicated balance sheet date.
Average Effective Rate is calculated for the year then ended.
The Company classifies its mortgage securities by interest rate
characteristics of the underlying single-family residential mortgage loans.
Fixed-rate mortgage securities either (i) have fixed rates of interest for their
entire terms, (ii) have an initial fixed-rate period of 10 years after
origination and then adjust annually based on a specified margin over 1-year
U.S. Treasury Securities ("1-year Treasuries"), or (iii) were previously
classified as medium-term and have adjusted to a fixed rate for the remainder of
their terms. Medium-term mortgage securities either (i) have an initial
fixed-rate period of 3 or 5 years after origination and then adjust annually
based on a specified margin over 1-year Treasuries, (ii) have initial
16
<PAGE> 12
CAPSTEAD MORTGAGE CORPORATION
interest rates that adjust one time, approximately 5 years following origination
of the mortgage loan, based on a specified margin over Fannie Mae yields for
30-year, fixed-rate commitments at the time of adjustment, or (iii) are
fixed-rate mortgage securities that have expected weighted average lives of 5
years or less. Adjustable-rate mortgage ("ARM") securities either (i) adjust
semiannually based on a specified margin over the 6-month London Interbank
Offered Rate ("LIBOR"), (ii) adjust annually based on a specified margin over
1-year Treasuries ("CMT"), (iii) adjust monthly based on a specific margin over
the Cost of Funds Index as published by the Eleventh District Federal Reserve
Bank ("COFI"), (iv) were previously classified as medium-term and have begun
adjusting annually based on a specified margin over 1-year Treasuries, or (v) in
the case of CMBS held as of December 31, 1999, adjust monthly based on a
specified margin over 30-day LIBOR.
Agency and U.S. Treasury securities consist of Agency Securities and U.S.
government-issued fixed-rate securities, commonly referred to as U.S. Treasury
notes or bonds (collectively, "Agency and U.S. Treasury Securities"). Agency
Securities have no foreclosure risk. Non-agency securities consist of private
mortgage pass-through securities backed primarily by single-family jumbo-sized
residential mortgage loans whereby the related credit risk of the underlying
loans is borne by AAA-rated private mortgage insurers, and other AAA-rated
private mortgage securities (together, "Non-agency Securities"). At December 31,
1998 Non-Agency Securities also included mortgage loans held for sale in
connection with curtailed mortgage production activities. Although investment
grade when acquired, CMBS held by the Company at December 31, 1999 carry credit
risk associated with the underlying commercial mortgage loans. Features of the
related CMBS issuance, including subordinated securities held by other
investors, help mitigate this risk. The maturity of mortgage-backed securities
is directly affected by the rate of principal prepayments on the underlying
loans.
NOTE 4 -- CMO COLLATERAL AND INVESTMENTS
CMO collateral consists of (i) fixed-rate, medium-term and adjustable-rate
mortgage securities collateralized by single-family residential mortgage loans
and (ii) related short-term investments, both pledged to secure CMO borrowings
("Pledged CMO Collateral"). CMO investments have included investments in
interest-only mortgage securities and investments in other CMO securities such
as principal-only mortgage securities. Interest-only mortgage securities are
entitled to receive 100 percent of coupon interest stripped from pools of
mortgage loans.
All principal and interest on pledged mortgage securities is remitted
directly to a collection account maintained by a trustee. The trustee is
responsible for reinvesting those funds in short-term investments. All
collections on the pledged mortgage securities and the reinvestment income
earned thereon are available for the payment of principal and interest on CMO
borrowings. Pledged mortgage securities are private mortgage pass-through
securities whereby the related credit risk of the underlying loans is borne by
AAA-rated private mortgage insurers or subordinated bonds within the related CMO
series to which the collateral is pledged. The Company has retained only $1.1
million of credit risk in the form of subordinated bonds associated with these
securities. The weighted average effective interest rate for total Pledged CMO
Collateral was 7.16 percent and 7.27 percent during 1999 and 1998, respectively.
17
<PAGE> 13
CAPSTEAD MORTGAGE CORPORATION
The components of CMO collateral and investments are summarized as follows
(in thousands):
<TABLE>
<CAPTION>
December 31
-----------------------
1999 1998
---------- ----------
<S> <C> <C>
Pledged CMO Collateral:
Pledged mortgage securities $3,283,848 $4,507,337
Short-term investments 760 14,879
Accrued interest receivable 19,461 27,361
---------- ----------
3,304,069 4,549,577
Unamortized premium 11,633 11,830
---------- ----------
3,315,702 4,561,407
CMO investments 3,184 9,867
---------- ----------
$3,318,886 $4,571,274
========== ==========
</TABLE>
During 1998 the value of interest-only mortgage securities, which trade in
a market with relatively few participants, was significantly depressed by
increasingly high rates of current and anticipated future mortgage prepayments
and sales of such securities by a number of large market participants. In 1998
the Company sold its entire $1.0 billion Agency Trust interest-only mortgage
securities portfolio at a loss of $251.9 million, net of related gains on
Derivatives, and wrote down to fair value remaining investments in interest-only
mortgage securities through an other-than-temporary impairment charge of $4.1
million. These remaining securities were sold in early 1999. Derivatives,
specifically interest rate floors, held to help offset the effects of falling
mortgage interest rates on the value of interest-only mortgage securities
under-performed relative to the loss in value of the assets they were intended
to hedge. As a result, these Derivatives no longer met hedge accounting criteria
requiring high ongoing correlation and, beginning in April 1998, changes in
value of these instruments were included in operating results rather than
recorded as an adjustment to the carrying amount of the hedged assets. Such
changes in value totaled $28.3 million prior to the sale of this portfolio and
are included in Gain (loss) on sale of mortgage assets and related derivative
financial instruments.
NOTE 5 -- BORROWINGS UNDER REPURCHASE ARRANGEMENTS
Borrowings made under uncommitted repurchase arrangements with investment
banking firms pursuant to which the Company pledges residential mortgage assets
as collateral generally have maturities of less than 31 days, although in
recognition of the potential for greater than normal mortgage finance market
liquidity constraints on or about December 31, 1999, the Company extended the
terms of a portion of its borrowings up to 4 months beyond year-end. Repurchase
arrangements with CMBS pledged as collateral generally have maturities similar
to the expected maturities of the related collateral. The terms and conditions
of these arrangements, including interest rates, are negotiated on a
transaction-by-transaction basis.
18
<PAGE> 14
CAPSTEAD MORTGAGE CORPORATION
Repurchase arrangements, and the related average effective interest rates
are classified by type of collateral and maturities as follows (dollars in
thousands):
<TABLE>
<CAPTION>
December 31, 1999 December 31, 1998
----------------------- ----------------------------
Weighted Weighted
Borrowings Average Borrowings Average
Outstanding Rate Outstanding Rate
----------- --------- ---------- ---------
<S> <C> <C> <C> <C>
Agency Securities (less than 31 days) $2,405,436 5.81% $1,839,868 5.47%
Agency Securities (31 to 90 days) 2,012,810 6.38 -- --
Agency Securities (over 90 days) 280,347 6.41 -- --
Non-agency Securities (over 90 days) 124,361 6.62 -- --
CMBS (over 1 year) 49,438 7.01 -- --
----------- ----------
$4,872,392 $1,839,868
=========== ==========
</TABLE>
The weighted average effective interest rate on borrowings under repurchase
arrangements was 5.16 percent and 5.55 percent during 1999 and 1998,
respectively. Interest paid on borrowings totaled $221.4 million, $347.6 million
and $339.1 million during 1999, 1998 and 1997, respectively. As of December 31,
1999, $5.1 billion of mortgage securities were pledged as collateral under
repurchase arrangements.
NOTE 6 -- COLLATERALIZED MORTGAGE OBLIGATIONS
Each series of CMOs issued consists of various classes of bonds, most of
which have fixed rates of interest. Interest is payable monthly or quarterly at
specified rates for all classes. Typically, principal payments on each series
are made to each class in the order of their stated maturities so that no
payment of principal will be made on any class of bonds until all classes having
an earlier stated maturity have been paid in full. The components of CMOs along
with selected other information are summarized as follows (dollars in
thousands):
<TABLE>
<CAPTION>
December 31
-----------------------------
1999 1998
----------- -----------
<S> <C> <C>
CMOs $ 3,281,464 $ 4,513,522
Accrued interest payable 18,096 25,609
----------- -----------
Total obligation 3,299,560 4,539,131
Unamortized discount (9,976) (17,807)
----------- -----------
$ 3,289,584 $ 4,521,324
=========== ===========
Range of average inte 5.13% to 9.45% 5.22% to 9.45%
Range of stated matur 2008 to 2028 2007 to 2028
Number of series 24 31
</TABLE>
The maturity of each CMO series is directly affected by the rate of
principal prepayments on the related Pledged CMO Collateral. Each series is also
subject to redemption, generally at the Company's option, provided that certain
requirements specified in the related indenture have been met (referred to as
"Clean-up Calls"); therefore, the actual maturity of any series is likely to
occur earlier than its stated maturity. The average effective interest rate for
all CMOs was 7.24 percent and 7.85 percent during 1999 and 1998, respectively.
Interest paid on CMOs totaled $260.2 million, $352.6 million and $263.2 million
during 1999, 1998 and 1997, respectively.
19
<PAGE> 15
CAPSTEAD MORTGAGE CORPORATION
NOTE 7 -- DISCLOSURES REGARDING FAIR VALUES
OF DEBT SECURITIES
Estimated fair values of debt securities have been determined using
available market information and appropriate valuation methodologies; however,
considerable judgment is required in interpreting market data to develop these
estimates. In addition, fair values fluctuate on a daily basis. Accordingly,
estimates presented herein are not necessarily indicative of the amounts that
could be realized in a current market exchange. The use of different market
assumptions and/or estimation methodologies may have a material effect on
estimated fair values.
The carrying amounts of cash and cash equivalents, receivables, payables
and borrowings under repurchase arrangements approximate fair value. The fair
value of Agency Securities, Non-agency Securities, CMBS and CMO investments were
estimated using either (i) quoted market prices when available, including quotes
made by lenders in connection with designating collateral for repurchase
arrangements, or (ii) offer prices for similar assets or market positions. The
fair value of Pledged CMO Collateral was based on projected cash flows, after
payment on the related CMOs, determined using market discount rates and
prepayment assumptions. The fair value of CMOs was based on the same method for
determining fair value of Pledged CMO Collateral adjusted for credit
enhancements. The maturity of mortgage assets is directly affected by the rate
of principal payments on the underlying mortgage loans and, for Pledged CMO
Collateral, Clean-up Calls of the remaining CMOs outstanding. The following
table summarizes fair value disclosures for financial instruments (in
thousands):
<TABLE>
<CAPTION>
December 31, 1999 December 31, 1998
-------------------------- ----------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
ASSETS:
Cash and cash equivalents $ 28,488 $ 28,488 $ 73,385 $ 73,385
Restricted cash and cash equivalents 2,500 2,500 26,500 26,500
Receivables 42,297 42,297 41,717 41,717
Mortgage investments 5,408,714 5,409,991 2,263,856 2,263,856
CMO collateral and investments 3,318,886 3,255,730 4,571,274 4,641,641
Derivatives* -- -- 12,618 12,618
LIABILITIES:
Payables 30,673 30,673 58,894 58,894
Borrowings under repurchase arrangements 4,872,392 4,872,392 1,839,868 1,839,868
CMOs 3,289,584 3,242,991 4,521,324 4,614,764
</TABLE>
* The average fair value of Derivatives held by the Company and not accorded
hedge accounting treatment during 1998 was $81.1 million. Remaining
Derivatives held by the Company were sold in January 1999.
20
<PAGE> 16
CAPSTEAD MORTGAGE CORPORATION
The following table summarizes fair value disclosures for
available-for-sale debt securities (in thousands):
<TABLE>
<CAPTION>
Gross Gross
Unrealized Unrealized Fair
Cost Gains Losses Value
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
AS OF DECEMBER 31, 1999
Mortgage investments:
Agency Securities:
Fixed-rate $1,060,898 $ 268 $51,589 $1,009,577
Medium-term 1,128,500 39 24,835 1,103,704
Adjustable-rate 3,126,971 4,659 22,586 3,109,044
Non-agency Securities 28,817 249 6 29,060
CMBS -- adjustable-rate 59,330 - - 59,330
CMO collateral and investments 103,142 697 184 103,655
---------- ------ ------- ----------
$5,507,658 $5,912 $99,200 $5,414,370
========== ====== ======= ==========
AS OF DECEMBER 31, 1998
Mortgage investments:
Agency Securities:
Fixed-rate $ 396,917 $3,466 $ 38 $ 400,345
Medium-term 317,544 862 373 318,033
Adjustable-rate 1,518,567 1,486 10,246 1,509,807
Non-agency Securities 34,815 856 - 35,671
CMO collateral and investments 190,916 2,927 158 193,685
---------- ------ ------- ----------
$2,458,759 $9,597 $10,815 $2,457,541
========== ====== ======= ==========
</TABLE>
Given the Company's current borrowing capacity, the Company has the ability
to hold mortgage assets for the foreseeable future; however, implementation of
the proposed investment strategy (see NOTE 1), could necessitate the recognition
in operating results of a portion of these losses.
Held-to-maturity debt securities consist of Pledged CMO Collateral and
collateral released from the related CMO indentures pursuant to Clean-up Calls
and held as Non-agency Securities. Sales of released CMO collateral occasionally
occur provided the collateral has paid down to within 15 percent of its original
issuance amounts. The following table summarizes fair value disclosures for debt
securities held-to-maturity (in thousands):
<TABLE>
<CAPTION>
Gross Gross
Unrealized Unrealized Fair
Cost Gains Losses Value
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
AS OF DECEMBER 31, 1999
Non-agency Securities .................... $ 97,999 $ 1,277 $ -- $ 99,276
Pledged CMO Collateral ................... 3,215,231 1,620 18,183 3,198,668
---------- ---------- ---------- ----------
$3,313,230 $ 2,897 $ 18,183 $3,297,944
========== ========== ========== ==========
AS OF DECEMBER 31, 1998
Pledged CMO Collateral ................... $4,377,589 $ 3,286 $ 26,359 $4,354,516
========== ========== ========== ==========
</TABLE>
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<PAGE> 17
CAPSTEAD MORTGAGE CORPORATION
The following table summarizes disclosures related to the disposition of
debt securities (in thousands):
<TABLE>
<CAPTION>
Year Ended December 31
-------------------------------------------------
1999 1998 1997
------------ ------------ ------------
<S> <C> <C> <C>
Sale of securities held available-for-sale:
Amortized cost $ 7,573 $ 6,233,622 $ 1,920,097
Gains (losses)* 1,761 (223,959) 24,043
Sale of released CMO collateral held-to-maturity:
Amortized cost -- 5,022 73,324
Gains -- 471 2,986
</TABLE>
* Represents the reclassification amounts included in other comprehensive
income (loss) as a component of the change in unrealized gains (losses) on
debt securities held available-for-sale. Excludes a January 1999 loss of
$23,000 on the sale of remaining Derivatives held by the Company.
NOTE 8 -- SALE OF MORTGAGE BANKING OPERATIONS AND
MORTGAGE BANKING RELATED DISCLOSURES
In December 1998 the Company sold its mortgage banking operations and its
investment in mortgage servicing rights to two affiliates of General Motors
Acceptance Corporation ("GMAC"). A gain of $2.9 million on these transactions
was recorded as a component of Net margin on mortgage banking operations. The
Company had a long-term subservicing relationship with GMAC, subservicing
approximately $19 billion of GMAC's single-family mortgage loans just prior to
the sale.
After retiring indebtedness related to the mortgage servicing portfolio,
related hedge instruments and loan production financing, and after certain
transaction costs, these transactions generated net cash proceeds of
approximately $500 million, including $26.5 million of Restricted cash and cash
equivalents held in escrow to secure related indemnifications. In accordance
with the terms of the related escrow agreement, during 1999, $3.9 million in
payments were made out of escrow to GMAC for pricing adjustments and $20.1
million was released to the Company, with the remaining $2.5 million scheduled
for release July 1, 2000. In addition, a prepayment protection settlement
payment of $16 million was remitted to GMAC in February 1999. These payments
were provided for in the determination of the gain on these transactions
recorded in 1998, along with other contract settlement provisions and
anticipated costs associated with exiting the mortgage banking operations,
including costs associated with the acceleration of benefits of restricted stock
grants to employees (see NOTE 11).
As of December 31, 1999, included in Accounts payable and accrued expenses
are remaining accruals of approximately $2.0 million pertaining primarily to
indemnifying GMAC for costs of mortgage loan buyback requests by investors in
excess of existing indemnifications by the originators of the loans. The Company
is unaware of any other material indemnification-related claims that may arise
prior to the release of the remaining funds held in escrow.
Prior to the sale of the mortgage banking operations, the Company incurred
impairment charges totaling $224.7 million reflecting the loss in value of its
investment in mortgage servicing rights caused by increasingly high rates of
then current and anticipated future mortgage prepayments. Derivatives,
specifically interest rate floors, held to offset the effects of falling
mortgage interest rates on the value of a designated portion of the servicing
22
<PAGE> 18
CAPSTEAD MORTGAGE CORPORATION
portfolio under-performed relative to the loss in value of the servicing rights
they were intended to hedge. As a result, these Derivatives no longer met hedge
accounting criteria requiring high ongoing correlation and, beginning in June
1998, changes in value of these instruments were included in operating results
rather than recorded as an adjustment to the carrying amount of the servicing
asset. In July 1998 the Company began to actively manage an expanded portfolio
of U.S. Treasury-based financial instruments that included interest rate floors,
U.S. Treasury note futures and 10-year U.S. Treasury notes to help mitigate the
effects of further declines in mortgage interest rates on the value of the
mortgage servicing rights. Substantially all of these instruments were sold by
December 31, 1998, including approximately $80 million in interest rate floors
and U.S. Treasury note futures positions sold to GMAC. During 1998 the Company
realized gains of $119.5 million on interest rate floors and U.S. Treasury note
futures, and $53.9 million on the sale of U.S. Treasury notes, net of related
taxes of $1.6 million.
NOTE 9 -- INCOME TAXES
Capstead and its qualified REIT subsidiaries file a separate federal income
tax return that does not include the operations of the non-REIT subsidiaries.
Provided all taxable income of Capstead and its qualified REIT subsidiaries is
distributed to stockholders within time limits prescribed by the Code, no income
taxes are due on this income. Taxable income of the non-REIT subsidiaries is
fully taxable. No income taxes were paid during 1999 or 1997; however, income
taxes paid during 1998 totaled $1.6 million. Effective tax rates differ
substantially from statutory federal income tax rates because of the effect of
the following items (in thousands):
<TABLE>
<CAPTION>
Year Ended December 31
----------------------------------------------
1999 1998 1997
---------- ---------- ----------
<S> <C> <C> <C>
Income taxes computed at the federal statutory rate $ 20,268 $ (82,167) $ 55,974
Nondeductible capital loss -- 83,651 --
Benefit of REIT status (20,268) (3,650) (46,893)
---------- ---------- ----------
Income taxes computed on income of non-REIT subsidiaries -- (2,166) 9,081
Benefit of previously unrecognized deferred income tax asset -- (667) (10,889)
Tax effect of capital contributions to non-REIT subsidiaries -- 3,783 --
Other -- 650 1,808
---------- ---------- ----------
$ -- $ 1,600* $ --
========== ========== ==========
</TABLE>
* The 1998 provision for income taxes is reflected in the statement of
operations as an offset to "Net margin on mortgage banking operations."
23
<PAGE> 19
CAPSTEAD MORTGAGE CORPORATION
Significant components of deferred income tax assets and liabilities are as
follows (in thousands):
<TABLE>
<CAPTION>
December 31
----------------------
1999 1998
------ ------
<S> <C> <C>
Deferred income tax assets:
Alternative minimum tax credit $1,751 $1,915
Net operating loss carryforwards 1,235 --
Other 619 864
------ ------
3,605 2,779
------ ------
Deferred income tax liabilities 344 357
------ ------
Net deferred tax assets $3,261 $2,422
====== ======
Valuation allowance $3,261 $2,422
====== ======
</TABLE>
At December 31, 1999 Capstead and its qualified REIT subsidiaries had
capital loss carryforwards for tax purposes of approximately $255 million which
expire in 2004. At December 31, 1999 the non-REIT subsidiaries had net operating
loss carryforwards for tax purposes of approximately $7.3 million, of which $3.7
million expires in 2013, and $3.6 million expires in 2019.
NOTE 10 -- STOCKHOLDERS' EQUITY AND PREFERRED STOCK
SUBJECT TO REPURCHASE
As of December 31, 1999, the Company had 4 series of convertible preferred
stock outstanding, each entitled to cumulative fixed dividends with redemption
and liquidation preferences as indicated in the table below (dollars in
thousands, except per share amounts):
<TABLE>
<CAPTION>
Per Share
- ----------------------------------------------------------------------- Aggregate
Preferred Annualized Conversion Redemption Liquidation Liquidation
Series Dividend Rate* Price Preference Preference
- --------- ---------- --------- ----------- ----------- ----------
<S> <C> <C> <C> <C> <C>
A $ 1.60 2.1707 $ 16.40 $ 16.40 $ 6,134
B 1.26 0.7537 12.50 11.38 189,739
C 0.56 1.0000 6.56 6.89 37,054
D 0.40 1.0000 4.76 4.76 25,599
</TABLE>
* Reflects number of common shares to be received for each preferred share
converted. During 1999, 2,260 Series B shares were converted into 1,703
common shares.
The preferred shares rank on a parity with each other and prior to the
common shares in the event of liquidation of the Company. The Series A and B
shares are nonvoting, while the Series C and D shares vote together as a single
group with the common shares. The Series A and B shares are currently redeemable
at the Company's option, while the Series C and D shares become redeemable at
the Company's option anytime after December 9, 2004. However, the Series C and D
shares may be repurchased by the Company at $4.903 per share, in certain
circumstances as discussed below. Additionally, the Series C and D shares
automatically convert into common shares on December 31, 2009 and December 31,
2005, respectively. Dividends are payable quarterly for the Series A, C and D
shares and monthly
24
<PAGE> 20
CAPSTEAD MORTGAGE CORPORATION
for the Series B shares. The following table summarizes dividends paid for each
preferred stock issue for the periods indicated (dollars in thousands, except
per share amounts):
<TABLE>
<CAPTION>
1999 1998 1997
----------------------- ----------------------- -----------------------
Preferred Per In Per In Per In
Series Share Aggregate Share Aggregate Share Aggregate
---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
A $ 1.60 $ 598 $ 1.60 $ 610 $ 1.60 $ 683
B 1.26 21,391 1.26 21,732 1.26 24,774
C 0.03 185 -- -- -- --
D 0.02 131 -- -- -- --
</TABLE>
On December 9, 1999 the Company issued 5,378,000 of the Series C shares and
5,378,000 of the Series D shares to an affiliate of Fortress Investment Group
LLC ("Fortress") at a cash price of $4.76 per share representing aggregate
proceeds of $51.2 million, before offering expenses. In connection with this
issuance, the Company entered into a Supplemental Agreement, as amended, which,
among other things, gives Fortress and Capstead each the right to cause the
repurchase by Capstead from Fortress of all, but not less than all, of the
Series C and D shares, for a price equal to 103 percent of the amount which
Fortress originally paid for the shares, plus all accrued and unpaid dividends
on those shares, should any of the four Fortress nominees to the Board of
Directors not receive a majority of the vote for election to the Board at the
Company's annual meeting of stockholders in April 2000 (the "Annual Meeting").
Fortress also has the right to cause the repurchase of the Series C and D
shares, plus all accrued and unpaid dividends, at a premium if (i) prior to the
Annual Meeting, the Company fails to conduct business in the ordinary course or
(ii) subsequent to the Annual Meeting, the Board of Directors fails to appoint a
certain Fortress representative to serve as Chairman and Chief Executive Officer
("CEO") and the Company's current Chairman and CEO to serve as Vice Chairman
(see NOTE 12). Should these shares be repurchased, the Company will incur a
non-recurring charge of approximately $2.5 million representing the repurchase
premium plus estimated offering expenses.
The Supplemental Agreement also provides that within 6 months of the
election of the Fortress nominees to the Board, Fortress will acquire at least 5
million common shares, through, at Fortress' option, open market purchases,
conversion of a portion of the Series C or D shares, or any combination thereof.
Further, the Supplemental Agreement provides that if there is a change in
control within 5 years of the election of the Fortress nominees to the Board of
Directors, then Fortress will have the right to cause the repurchase of the then
outstanding Series C and D shares at the original per share purchase price, plus
all accrued and unpaid dividends. A change in control is deemed to have occurred
if (i) a person acquires 25 percent of the voting power of the Company, (ii)
directors elected and qualified at the Annual Meeting cease to constitute at
least a majority of the Board of Directors, or (iii) the Company is a party to a
business combination not approved by certain Fortress representatives on the
Board of Directors.
The weighted average shares used to calculate diluted net income (loss) per
common share in 1999 and 1997 differs from weighted average common shares
outstanding because of the dilutive effects of stock options and the potential
conversion of preferred stock into common stock in those years. In 1998 stock
options and preferred share conversions were antidilutive in calculating net
loss per common share; therefore, diluted net loss per common
25
<PAGE> 21
CAPSTEAD MORTGAGE CORPORATION
share was the same as basic net loss per common share. Dilutive options
increased weighted average shares by 20,000 and 1,101,000 shares in 1999 and
1997, respectively. The assumed conversion of the newly issued Series C and D
shares increased weighted average shares by 678,000 during 1999, while the
assumed conversion of the Series A and B shares increased weighted average
shares by 15,665,000 shares during 1997.
In December 1998 the Company completed a previously authorized repurchase
of 1 million common shares at an average price of $4.10 per share (including
transaction costs). In early January 1999, in accordance with the terms of the
related employee benefit plans, 85,583 formerly restricted common shares were
repurchased at $4.12 per share from employees in order to assist them with
meeting their federal income tax obligations resulting from the lapsing of
restrictions on stock awards with the December 1998 sale of the mortgage banking
operations. On February 4, 1999 the Company's Board of Directors authorized the
repurchase of up to 6 million common shares and up to 2 million Series B shares.
As of December 31, 1999, the Company had repurchased 3,607,500 common shares at
an average price of $4.92 (including transaction costs) and 622,000 Series B
shares at an average price of $11.57 (including transaction costs) pursuant to
this repurchase program. On January 25, 2000 the Company repurchased 11,137,000
common shares at a price of $4.55 per share pursuant to a tender offer that
commenced December 9, 1999 and closed January 14, 2000.
In previous years the Company used several programs designed to raise new
equity capital at favorable prices. These programs were indefinitely suspended
when the prices of the Company's equity issues declined during the second
quarter of 1998. The following tables summarize capital raised through these
programs during 1998 and 1997 (dollars in thousands):
<TABLE>
<CAPTION>
1998 1997
----------------------- -----------------------
Net Net
Shares Proceeds Shares Proceeds
---------- --------- ---------- ----------
Common Stock:
<S> <C> <C> <C> <C>
Dividend reinvestments 149,267 $ 2,901 810,791 $ 18,195
Direct stock purchases 426,458 8,155 2,565,434 63,121
Structured equity shelf 1,751,500 33,349 4,108,900 97,938
---------- --------- ---------- ----------
2,327,225 44,405 7,485,125 179,254
========== --------- ========== ----------
Series B Preferred Stock:
Dividend reinvestments 74,376 1,085 185,523 3,120
Structured equity shelf 199,600 2,952 646,500 11,079
---------- --------- ---------- ----------
273,976 4,037 832,023 14,199
========== --------- ========== ----------
$ 48,442 $ 193,453
========= ==========
</TABLE>
Dividend reinvestments allow existing stockholders to convert cash
dividends into newly issued shares. Similarly, direct stock purchases allow
investors the opportunity to acquire additional shares directly from the
Company, subject to certain limitations. Structured equity shelf issuances
represent new shares issued by the Company on a daily basis either directly into
the market or in larger blocks to qualified buyers, subject to certain
limitations.
Option exercises by employees during 1998 and 1997 resulted in net
additions to capital of $1.9 million and $5.8 million, respectively. No options
were exercised in 1999.
The Company's Charter provides that if the Board of Directors determines in
good faith that the direct or indirect ownership of stock of Capstead has become
concentrated to an extent which would cause Capstead to fail to qualify as a
REIT, the Company may redeem or
26
<PAGE> 22
CAPSTEAD MORTGAGE CORPORATION
repurchase, at fair market value, any number of common and/or preferred shares
sufficient to maintain or bring such ownership into conformity with the Code. In
addition, the Company may refuse to transfer or issue common and/or preferred
shares to any person whose acquisition would result in Capstead being unable to
comply with the requirements of the Code. Finally, the Charter provides that the
Company may redeem or refuse to transfer any capital shares of Capstead
necessary to prevent the imposition of a penalty tax as a result of ownership of
such shares by certain disqualified organizations, including governmental bodies
and tax-exempt entities that are not subject to tax on unrelated business
taxable income.
NOTE 11 -- EMPLOYEE BENEFIT PLANS
The Company sponsors stock plans for directors and employees to provide for
the issuance of stock options and other incentive-based stock awards
(collectively, the "Plans"). The Plans provide for the issuance of up to an
aggregate of 7,512,500 common shares. Options granted have terms and vesting
requirements at the grant date of up to 10 years. Prior to a restructuring of
long-term incentive compensation for key officers on January 2, 1998 which
eliminated this feature, most of the outstanding stock options provided for the
annual granting of dividend equivalent rights ("DERs") that permitted the option
holder to obtain additional common shares based upon formulas set forth in the
Plans. The following table provides information regarding common stock option
activity for the periods indicated:
<TABLE>
<CAPTION>
Number of Weighted Average
Shares Exercise Price
--------- ---------------
<S> <C> <C>
As of December 31, 1996 (1,716,334 exercisable) 2,370,570 $ 13.12
Granted (average fair value: $3.07 per share) 622,250 23.51
Exercised (431,568) 11.00
Canceled (1,125) 12.00
DERs granted (average fair value: $24.00 per share) 188,328 --
---------
As of December 31, 1997 (1,878,421 exercisable) 2,748,455 14.91
Granted (average fair value: $1.48 per share) 1,814,250 20.00
Exercised (161,546) 11.75
Canceled (690,127) 6.97
DERs granted (average fair value: $20.00 per share) 237,743 --
---------
As of December 31, 1998 (3,948,775 exercisable)* 3,948,775 17.87
Granted (average fair value: $0.69 per share) 11,250 4.13
Canceled* (2,462,448) 17.81
---------
As of December 31, 1999 (1,497,577 exercisable) 1,497,577 17.86
=========
</TABLE>
* With the December 1998 sale of the mortgage banking operations, all
outstanding stock option awards became 100 percent vested. On June 30, 1999
unexercised options held by former employees of Capstead Inc. were
forfeited under the terms of the Plans.
27
<PAGE> 23
CAPSTEAD MORTGAGE CORPORATION
Weighted average exercise price and remaining life information for
significant option grants outstanding at December 31, 1999 were as follows:
<TABLE>
<CAPTION>
Weighted
Average
Options Options Exercise Remaining
Outstanding Exercisable Price Life (Years)
--------------------------------------- --------------- ---------------- ----------------- ------------
<S> <C> <C> <C> <C>
Options granted January 1998 648,878 648,878 $19.80 8
Options granted January 1997 245,147 245,147 23.15 7
Options granted January 1996 190,541 190,541 15.22 6
Options granted April 1994 310,087 310,087 12.83 4
</TABLE>
In connection with the January 2, 1998 restructuring of long-term incentive
compensation for key officers, the Company canceled existing DER option grants
totaling 452,627 common shares and eliminated the right to receive future DER
award grants in exchange for cash settlements aggregating $10.5 million and
452,627 restricted common shares. The restricted stock had a grant date fair
value of $20 per share and was granted subject to certain restrictions,
including continuous employment, which generally lapsed over 5 years.
During 1998 and 1997 the Company also issued restricted stock grants for an
aggregate of 35,000 and 201,000 common shares to employees completing their
first year of employment with the Company at grant date fair values averaging
$11.18 and $24.35 per share, respectively. These grants were subject to certain
restrictions, including continuous employment, which generally lapsed over 10
years.
Costs associated with restricted stock grants (measured by the fair value
of the Company's common stock on the date of grant multiplied by the number of
shares granted) have been recognized as compensation expense over the period
restricted. However, with the December 1998 sale of the mortgage banking
operations, all remaining restrictions lapsed under the terms of the Plans.
Therefore, the gain on sale of the mortgage banking operations includes a $11.0
million charge to eliminate all deferred compensation related to restricted
stock grants.
The Company applies Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees," and related Interpretations in accounting for
stock awards. Accordingly, no compensation expense has been recognized for stock
awards other than for DERs and restricted stock grants. Related compensation
costs, excluding the charge mentioned above, totaled $2.4 million and $6.3
million in 1998 and 1997, respectively. There were no related compensation costs
during 1999. The effect of determining compensation cost for stock options
granted since the beginning of 1995, based upon the estimated fair value at the
grant date consistent with the methodology prescribed under Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation," would have been 3 cents per share or less on diluted net income
(loss) per common share for each of the last 3 years. This effect on diluted net
income (loss) per common share was determined using a Black-Scholes option
pricing model and, depending upon each individual option grant during the last
three years, dividend yields of 10 percent to 12 percent, volatility factors of
27.8 percent to 53.0 percent, expected life assumptions of 3 to 5 years and
risk-free rates of 5 percent to over 7 percent. This effect may not be
representative of the pro forma effect on future operating results.
The Company also sponsors a qualified defined contribution retirement plan
for all employees. The Company matches up to 50 percent of a participant's
voluntary contribution
28
<PAGE> 24
CAPSTEAD MORTGAGE CORPORATION
up to a maximum of 6 percent of a participant's compensation and may make
additional contributions of up to another 3 percent of a participant's
compensation. All Company contributions are subject to certain vesting
requirements. Contribution expenses were $113,000, $709,000 and $634,000 in
1999, 1998 and 1997, respectively.
NOTE 12 -- COMMITMENTS AND CONTINGENCIES
During 1998, 24 purported class action lawsuits were filed against the
Company and certain of its officers alleging, among other things, that the
defendants violated federal securities laws by publicly issuing false and
misleading statements and omitting disclosure of material adverse information
regarding the Company's business during various periods between January 28, 1997
and July 24, 1998. The complaints claim that as a result of such alleged
improper actions, the market price of the Company's equity securities were
artificially inflated during that time period. The complaints seek monetary
damages in an undetermined amount. In March 1999 these actions were
consolidated. The time by which the Company is to respond has not yet run. The
Company believes it has meritorious defenses to the claims and intends to
vigorously defend the actions. Based on available information, management
believes the resolution of these suits will not have a material adverse effect
on the financial position of the Company.
If the Fortress nominees to the Board of Directors receive a majority of
the vote for election to the Board at the Annual Meeting, it is expected that
the current Chairman and CEO will terminate his employment with the Company,
although he is expected to remain on the Board of Directors as Vice Chairman. In
this event, the Company will incur a non-recurring severance charge of up to
$3.7 million under the terms of an employment agreement entered into with the
CEO in 1992.
NOTE 13 -- NET INTEREST INCOME ANALYSIS (UNAUDITED)
The following table summarizes interest income and interest expense and
average effective interest rates for the periods indicated (dollars in
thousands):
<TABLE>
<CAPTION>
1999 1998 1997
--------------------- --------------------- ----------------------
Average Average Average
Amount Rate Amount Rate Amount Rate
---------------------------------------- ---------- ---------- ---------- ---------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C>
Interest income:
Mortgage securities and other
investments $293,841 5.87% $311,807 5.89% $339,980 6.28%
CMO collateral and investments 269,318 7.16 355,391 7.28 354,279 7.84
-------- -------- --------
Total interest income 563,159 667,198 694,259
-------- -------- --------
Interest expense:
Borrowings under repurchase
arrangements 232,852 5.16 313,858 5.55 329,635 5.53
CMOs 270,081 7.24 340,248 7.85 281,497 7.63
-------- -------- --------
Total interest expense 502,933 654,106 611,132
-------- -------- --------
Net interest $ 60,226 $ 13,092 $ 83,127
======== ======== =========
</TABLE>
29
<PAGE> 25
CAPSTEAD MORTGAGE CORPORATION
The following tables summarize the changes in interest income and interest
expense due to changes in interest rates versus changes in volume for the
periods indicated (in thousands):
<TABLE>
<CAPTION>
1999/1998*
------------------------------------------
Rate Volume Total
- ------------------------------------------------------- -------------- ---------------- ----------
<S> <C> <C> <C>
Interest income:
Mortgage securities and other investments $ (793) $ (17,173) $ (17,966)
CMO collateral and investments (5,673) (80,400) (86,073)
---------- ----------- -----------
Total interest income (6,466) (97,573) (104,039)
---------- ----------- ----------
Interest expense:
Borrowings under repurchase arrangements (20,758) (60,248) (81,006)
CMOs (25,188) (44,979) (70,167)
--------- ----------- -----------
Total interest expense (45,946) (105,227) (151,173)
--------- ---------- ----------
Net interest $ 39,480 $ 7,654 $ 47,134
========= =========== ==========
</TABLE>
<TABLE>
<CAPTION>
1998/1997*
-------------------------------------------
Rate Volume Total
------------------------------------------------ -------------- ---------------- -----------
<S> <C> <C> <C>
Interest income:
Mortgage securities and other investments $ (20,988) $ (7,185) $ (28,173)
CMO collateral and investments (26,168) 27,280 1,112
--------- -------- --------
Total interest income (47,156) 20,095 (27,061)
--------- -------- --------
Interest expense:
Borrowings under repurchase arrangements 1,010 (16,787) (15,777)
CMOs 8,591 50,160 58,751
--------- -------- --------
Total interest expense 9,601 33,373 42,974
--------- -------- --------
Net interest $ (56,757) $ (13,278) $(70,035)
========== =========== ========
</TABLE>
* The change in interest due to both volume and rate has been allocated
to volume and rate changes in proportion to the relationship of the
absolute dollar amounts of the change in each.
NOTE 14 -- QUARTERLY RESULTS (UNAUDITED)
The following is a summary of quarterly results of operations (in
thousands, except percentages and per share amounts). See NOTES 1 and 8 for
discussion of significant changes to the Company's operations during 1999 and
1998 that have impacted quarterly operating results and may impact future
operations.
<TABLE>
<CAPTION>
Year Ended December 31, 1999
--------------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
- --------------------------------------------------------- ------------- -------------- --------------- -----------
<S> <C> <C> <C> <C>
Interest income $ 124,342 $ 146,191 $ 147,817 $ 144,809
Interest and related expenses 112,058 128,764 132,511 131,614
------------- -------------- --------------- -----------
Net margin on mortgage assets and other
investments 12,284 17,427 15,306 13,195
Other operating revenue (expense) 1,623 (744) (784) (398)
------------- -------------- --------------- -----------
Net income $ 13,907 $ 16,683 $ 14,522 $ 12,797
============= ============== =============== ===========
Net income per common share:
Basic $ 0.14 $ .19 $ 0.16 $ 0.13
Diluted 0.14 0.19 0.16 0.13
Return on average stockholders' equity
and preferred stock subject to repurchase 8.16% 9.88% 8.66% 7.57%
</TABLE>
30
<PAGE> 26
CAPSTEAD MORTGAGE CORPORATION
<TABLE>
<CAPTION>
Year Ended December 31, 1998
--------------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
- --------------------------------------------------------- ------------- -------------- --------------- -----------
<S> <C> <C> <C> <C>
Interest income $193,019 $ 201,871 $144,683 $127,625
Interest and related expenses 178,652 191,358 162,891 126,674
--------- --------- -------- --------
Net margin on mortgage assets and other
investments 14,367 10,513 (18,208) 951
Net margin on mortgage banking operations 14,845 (27,153) 13,215 10,914
Other operating revenue (expense) 5,858 (251,492) (6,832) (1,742)
--------- --------- -------- --------
Net income (loss) $ 35,070 $(268,132) $(11,825) $ 10,123
========= ========= ======== ========
Net income (loss) per common share:
Basic $0.50 $ (4.47) $ (0.28) $ 0.07
Diluted 0.48 (4.47) (0.28) 0.07
Return on average stockholders' equity 14.59% (117.53%) (7.00%) 5.97%
</TABLE>
NOTE 15 -- MARKET AND DIVIDEND INFORMATION (UNAUDITED)
The New York Stock Exchange trading symbol for the Company's common stock
is CMO. There were 4,995 holders of record of the Company's common stock at
December 31, 1999. In addition, depository companies held stock for 34,467
beneficial owners. The high and low stock sales prices and dividends declared on
common stock for the periods indicated were as follows:
<TABLE>
<CAPTION>
Year Ended December 31, 1999 Year Ended December 31, 1998
------------------------------------ ----------------------------------
Stock Prices Stock Prices
---------------------- Dividends --------------------- Dividends
High Low Declared High Low Declared
-------------------------- --------- ------------ ------------- -------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
First quarter $6 $4 $0.14 $21 11/16 $18 1/2 $0.50
Second quarter 6 3/16 5 1/8 0.18 21 1/3 7 15/16 0.50
Third quarter 5 3/4 3 7/8 0.16 8 3/8 2 3/16 --
Fourth quarter 4 3/8 3 11/16 0.12 4 5/8 2 1/8 --
</TABLE>
31
<PAGE> 27
CAPSTEAD MORTGAGE CORPORATION
SELECTED FINANCIAL DATA
(In thousands, except percentages and per share amounts)
<TABLE>
<CAPTION>
Year Ended December 31
---------------------------------------------------------------------
1999 1998 1997 1996
---------------------------------------------------------------------
<S> <C> <C> <C> <C>
SELECTED CONSOLIDATED STATEMENT
OF OPERATIONS DATA:
Interest income $ 563,159 $ 667,198 $ 694,259 $ 662,964
Interest and related expense 504,947 659,575 616,287 589,606
----------- ----------- ----------- -----------
Net margin on mortgage assets and
other investments 58,212 7,623 77,972 73,358
Net margin on mortgage banking operations* -- 11,821 59,422 49,122
Other operating revenue (expense)** (303) (254,208) 22,532 4,748
----------- ----------- ----------- -----------
Net income (loss) $ 57,909 $ (234,764) $ 159,926 $ 127,228
=========== =========== =========== ===========
Net income (loss) per common share:***
Basic $ 0.61 $ (4.22) $ 2.62 $ 2.37
Diluted 0.60 (4.22) 2.35 2.07
Return on average stockholders' equity
and preferred stock subject to repurchase 8.56% (28.83%) 19.12% 18.41%
Cash dividends paid per share:
Common $ 0.60 $ 1.00 $ 2.40 $ 2.11 1/2
$1.60 Series A Preferred 1.60 1.60 1.60 1.60
$1.26 Series B Preferred 1.26 1.26 1.26 1.26
$0.56 Series C Preferred 0.03 -- -- --
$0.40 Series D Preferred 0.02 -- -- --
Average number of common shares outstanding:***
Basic 58,348 60,948 51,257 38,317
Diluted 59,046 60,948 68,023 61,501
SELECTED CONSOLIDATED BALANCE SHEET DATA:
Mortgage securities and other investments $ 5,408,714 $ 2,369,602 $ 6,114,130 $ 4,840,417
CMO collateral and investments 3,318,886 4,571,274 5,195,436 4,501,646
Mortgage servicing rights* -- -- 669,062 626,094
Total assets 8,807,039 7,100,287 12,357,515 10,157,338
Borrowings under repurchase arrangements 4,872,392 1,839,868 7,099,706 5,462,856
Collateralized mortgage obligations 3,289,584 4,521,324 4,309,455 3,861,892
Preferred stock subject to repurchase 50,584 -- -- --
Stockholders' equity 563,806 680,201 888,608 726,869
MORTGAGE BANKING DATA:*
Primary servicing portfolio $ -- $ -- $42,059,027 $35,562,597
Subservicing portfolio -- -- 11,834,091 2,155,873
<CAPTION>
Year Ended December 31
---------------------
1995
---------------------
<S> <C>
SELECTED CONSOLIDATED STATEMENT
OF OPERATIONS DATA:
Interest income $ 623,160
Interest and related expense 588,421
-----------
Net margin on mortgage assets and
other investments 34,739
Net margin on mortgage banking operations* 41,253
Other operating revenue (expense)** 1,367
-----------
Net income (loss) $ 77,359
===========
Net income (loss) per common share:***
Basic $ 1.10
Diluted 1.09
Return on average stockholders' equity
and preferred stock subject to repurchase 11.91%
Cash dividends paid per share:
Common $ 1.09 1/3
$1.60 Series A Preferred 1.60
$1.26 Series B Preferred 1.26
$0.56 Series C Preferred --
$0.40 Series D Preferred --
Average number of common shares outstanding:***
Basic 34,631
Diluted 35,883
SELECTED CONSOLIDATED BALANCE SHEET DATA:
Mortgage securities and other investments $ 4,556,049
CMO collateral and investments 4,796,925
Mortgage servicing rights* 418,794
Total assets 9,903,606
Borrowings under repurchase arrangements 4,628,782
Collateralized mortgage obligations 4,538,863
Preferred stock subject to repurchase --
Stockholders' equity 664,724
MORTGAGE BANKING DATA:*
Primary servicing portfolio $25,557,629
Subservicing portfolio --
</TABLE>
NOTE: See "Management's Discussion and Analysis of Financial Condition" and
"Notes to Consolidated Financial Statements" for discussion of
changes to the Company's operations that are expected to impact
future operating results.
* The mortgage banking operations, including related mortgage servicing
rights, were sold in December 1998.
** Includes substantial losses incurred in 1998 from the sale of
mortgage assets, principally interest-only mortgage securities.
*** Net income (loss) per common share and average number of common
shares outstanding amounts prior to 1997 have been restated as
required to comply with Statement of Financial Accounting Standards
No. 128, "Earnings per Share." For further discussion of net income
(loss) per common share, see "Notes to Consolidated Financial
Statements." Amounts have been adjusted for 3-for-2 common stock
splits effective October 30, 1995 and July 31, 1996.
32
<PAGE> 28
CAPSTEAD MORTGAGE CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
FINANCIAL CONDITION
OVERVIEW
Capstead Mortgage Corporation, a mortgage investment firm, earns income
from investing in mortgage assets on a leveraged basis and from other investment
strategies. During 1999 the Company's primary focus consisted of managing a
portfolio of single-family residential mortgage-backed securities issued by
government-sponsored entities, either Fannie Mae, Freddie Mac or Ginnie Mae
("Agency Securities").
In response to the lower long-term interest rate environment experienced in
1998, which contributed to liquidity issues for the mortgage finance industry,
the Company significantly reduced its mortgage asset portfolios and sold its
mortgage banking operations during 1998, which substantially increased the
Company's liquidity but diminished its earnings capacity. After acquiring $3.3
billion of Agency Securities during the first quarter of 1999, the Company
maintained a mortgage investment portfolio of approximately $5.5 billion
throughout the remainder of 1999 financed by short-term borrowings and equity.
In addition, since share repurchases began in December 1998, and including the
January 2000 repurchase of 11,137,000 common shares pursuant a tender offer
announced in December 1999, the Company has repurchased 25.7 percent of its
outstanding common shares and 3.6 percent of its $1.26 Cumulative Convertible
Preferred Stock, Series B ("Series B" shares). Portfolio acquisitions, combined
with share repurchases, increased the Company's leverage ratio (borrowings to
stockholders' equity and preferred stock subject to repurchase, before other
comprehensive income (loss) adjustments) from 2.7:1 at December 31, 1998 to
7.4:1 at year-end (after adjusting for the results of the tender offer completed
in January 2000).
Earnings from this larger portfolio of Agency Securities allowed the first
quarter 1999 reinstatement of the payment of quarterly common stock dividends
that had been curtailed in mid-1998. However, earnings have declined in recent
quarters primarily because of actions taken by the Federal Reserve beginning in
June of 1999 to increase short-term interest rates thus reducing net interest
margins. Additionally, higher long-term interest rates have contributed to
declines in the Company's book value per common share because of declines in the
value of these securities.
In December 1999 the Company issued $51.2 million in voting preferred stock
to an affiliate of Fortress Investment Group LLC ("Fortress"), a real estate
investment firm with experience in investing in a variety of asset types across
the credit spectrum. In addition, the Company is considering modifying its
investment strategy to invest in credit-sensitive commercial mortgage-backed
securities ("CMBS") and residential mortgage-backed securities (see "Investment
by Fortress and Potential Changes in Management" and "Proposed Change in
Investment Strategy").
MORTGAGE SECURITIES AND OTHER INVESTMENTS
Mortgage securities and other investments consist primarily of
single-family residential mortgage-backed securities, most of which are Agency
Securities. Agency Securities have
33
<PAGE> 29
CAPSTEAD MORTGAGE CORPORATION
no foreclosure risk; however, the Company is subject to reduced net interest
margins during periods of rising short-term interest rates or increasing
prepayment rates (see "Effects of Interest Rate Changes"). In 1998 the Company
also held investments in government-issued securities, commonly referred to as
U.S. Treasury notes or bonds. Non-agency securities consist of private mortgage
pass-through securities whereby the related credit risk of the underlying loans
is borne by AAA-rated private mortgage insurers, and other AAA-rated private
mortgage securities (together, "Non-agency Securities"). The Company classifies
its mortgage securities and other investments by interest rate characteristics
of the underlying loans or the securities themselves (see NOTE 3 to the 1999
consolidated financial statements). Mortgage securities and other investments
are financed under repurchase arrangements with investment banking firms
pursuant to which specific securities held within the portfolios are pledged as
collateral (see "Liquidity and Capital Resources").
The following yield and cost analysis illustrates results achieved during
the most recent quarter for each component of the Company's mortgage investment
portfolio and its currently projected first quarter 2000 earnings capacity (see
footnotes below regarding assumptions used to develop projected asset yield and
borrowing rate information):
<TABLE>
<CAPTION>
As of December 31,
Average for the Quarter Ended 1999
December 31, 1999 -------------------- Projected
--------------------------------- Purchase First Lifetime
Actual Actual Premiums Quarter Prepayments
Basis Yield/Cost Runoff (Discounts) Basis Yield/Cost Assumption
- ------------------------- ---------- ---------- ------ ----------- ----- ---------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
* * **
Agency Securities:
FNMA/FHLMC:
Fixed-rate $1,071,302 6.22% 7% $(2,924) $1,060,898 6.21% 8%
Medium-term 1,150,170 5.96 13 4,516 1,128,500 5.93 18
ARMs:
LIBOR/CMT 964,778 6.14 23 20,824 932,086 6.31 40
COFI 250,236 5.57 15 1,570 244,143 5.73 18
GNMA ARMs 2,004,103 5.84 18 26,083 1,950,742 6.03 24
----------- ---- -- ------- ---------- ---- --
5,440,589 5.98 16 50,069 5,316,369 6.08 22
Non-agency Securities 131,587 8.14 24 385 126,816 7.93 35
CMBS - adjustable-rate 6,914 8.53 - (852) 59,330 8.57 -
----------- ---- --- ------- ------------ ---- ---
5,579,090 6.03 17% $49,602 5,502,515 6.17 22%
== ======= ==
Less:
Mark to market 76,010 - 93,801 -
Borrowings*** 5,002,276 5.54 4,872,392 5.87
----------- ---- ---------- ----
Capital employed/
financing spread $ 500,804 0.49% $ 536,322 0.30%
=========== ==== ========== ====
Return on assets**** 0.95% 0.87%
</TABLE>
* Basis is the Company's investment including unamortized purchase premiums
and discounts before the mark to market included in "Other comprehensive
income (loss)."
** Projected yields reflect adjustable-rate mortgage ("ARM") security coupon
resets and lifetime prepayment assumptions as adjusted for expected
prepayments over the next 3 months. These projections do not reflect any
changes in portfolio composition resulting from modifications to the
Company's investment strategy. Actual yields realized in future periods
will largely depend upon (i) changes in portfolio composition (ii) ARM
security coupon resets, (iii) actual prepayments and (iv) any changes in
lifetime prepayment assumptions.
*** Projected borrowing rates reflect the full impact of the November 1999
Federal Reserve 25 basis point rate increase and include the 25 basis
point increase in early February 2000. Borrowing rates may increase
further depending largely upon future actions by the Federal Reserve to
increase short-term interest rates.
**** The Company uses its liquidity to pay down borrowings. Return on assets
is calculated assuming the use of this liquidity to reduce borrowing
costs.
34
<PAGE> 30
CAPSTEAD MORTGAGE CORPORATION
During 1999 the Company acquired approximately $4.3 billion of Agency
Securities and called for redemption 7 series of collateralized mortgage
obligations ("CMOs") adding $157 million to the Non-agency Securities portfolio.
Consistent with the proposed modification of the Company's investment strategy,
in December the Company acquired $59.3 million of adjustable-rate CMBS from a
third party not affiliated with Fortress. Additional modest investments in CMBS
have been made subsequent to year-end. Although these CMBS were rated investment
grade when purchased, they do expose the Company to credit risk (see "Risks
Associated with Credit-sensitive Investments"). Runoff on mortgage investments
totaled approximately $1.2 billion. Investments in fixed-rate mortgage
securities as a percent of total mortgage investments were 20.8 percent at
December 31, 1999 compared to 22.9 percent at December 31, 1998. Medium-term
mortgage securities increased to 20.4 percent at December 31, 1999 compared to
13.4 percent at December 31, 1998, while ARM investments declined to 57.7
percent from 63.7 percent at December 31, 1998. The Company's leverage ratio
increased to 7.4:1 at December 31, 1999 (after adjusting for the results of the
tender offer completed in January 2000) from 2.7:1 at December 31, 1998.
The unamortized net premium paid for these portfolios (referred to as
"purchase premiums (discounts)") increased to $49.6 million at December 31, 1999
from $33.7 million at December 31, 1998, while actually declining as a
percentage of related unpaid principal balances to 0.91 percent this year-end
from 1.44 percent December 31, 1998. Purchase premiums (discounts) are amortized
to income as yield adjustments based on both actual prepayments and lifetime
prepayment assumptions. Actual prepayments declined throughout 1999 as mortgage
interest rates increased which has had a favorable impact on yields (see
"Effects of Interest Rate Changes"). Prepayments on Fannie Mae and Freddie Mac
medium-term and adjustable-rate Agency Securities declined to an annualized rate
of 15.5 percent in December 1999 from 48.4 percent in December 1998. Prepayments
on Ginnie Mae ARMs declined to an annualized rate of 16.9 percent in December
1999, from 37.9 percent in December 1998.
Additionally, yields on ARM securities are expected to improve as interest
rates on mortgage loans underlying these securities reset to levels more
reflective of the current interest rate environment. In addition, yields are
expected to improve somewhat as prepayments are reinvested in higher yielding
investments. Overall, if interest rates stabilize at February 2000 levels,
yields on the Company's ARM securities could improve as much as 71 basis points
over the next 12 months. Conversely, if interest rates decline from these
levels, such yield improvements will likely not be achieved (see "Effects of
Interest Rate Changes").
The Company's borrowing rates are largely dependent upon actions of the
Federal Reserve to change short-term interest rates. After having reduced
short-term interest rates by a total of three-quarters of one percentage point
late in 1998, the Federal Reserve has increased short-term interest rates by
one-quarter of one percentage point at each of its June 30, August 24, November
16, 1999 and February 2, 2000 meetings and may increase rates further. If
short-term borrowing rates continue to rise, improving mortgage asset yields
over the next 12 months would not fully keep pace and net interest margins would
further decline (see "Effects of Interest Rate Changes").
35
<PAGE> 31
CAPSTEAD MORTGAGE CORPORATION
CMO COLLATERAL AND INVESTMENTS
The Company had been an active issuer of CMOs and other securities backed
by single-family jumbo-sized residential mortgage loans obtained through a
mortgage loan conduit business that the Company exited in 1995. Since then, the
Company has maintained finance subsidiaries with remaining capacity to issue
CMOs and other securitizations ("securitization shelves"). In an effort to
recover costs associated with these securitization shelves, and to potentially
add to its CMO administration activities, the Company from time to time
purchases mortgage loans from originators or conduits and issues CMOs or other
securities backed by these loans. The Company may or may not retain a
significant residual economic interest in these securitizations. In 1997 and
1998 the Company issued 4 such CMOs totaling $2.2 billion. Also in 1998, in
order to enhance its liquidity, the Company issued a $345 million CMO backed by
Non-agency Securities. No CMOs were issued in 1999.
The related credit risk of the mortgage loans collateralizing CMOs issued
by the Company is borne by AAA-rated private mortgage insurers or by
subordinated bonds within the related CMO series to which the collateral is
pledged. The Company has retained only $1.1 million of credit risk in the form
of subordinated bonds associated with these securities. The Company also
retained residual interests in certain of these securitizations primarily with
the characteristics of interest-only mortgage securities. Interest-only mortgage
securities are entitled to receive all or some portion of the interest stripped
from the mortgage loans underlying the securities.
As of December 31, 1999, the Company's CMO investments (defined as CMO
collateral and investments, net of related bonds) had been reduced to $29.3
million, down from $50.0 million at December 31, 1998. Included in this net
investment are $11.6 million and $10.0 million of the remaining CMO collateral
premiums and bond discounts, respectively. Similar to purchase premiums on the
Company's mortgage investments, CMO collateral premiums and bond discounts,
along with most of remaining CMO investments, are amortized to income as CMO
collateral yield or bond expense adjustments based on both actual prepayments
and lifetime prepayment assumptions (see "Effects of Interest Rate Changes").
INVESTMENT BY FORTRESS AND POTENTIAL CHANGES IN MANAGEMENT
In connection with the December 1999 issuance of voting preferred stock to
Fortress, it was agreed that stockholders would be asked to approve a new seven
member Board of Directors at the Company's annual meeting of stockholders in
April 2000, four of whom have been nominated by Fortress. It is expected that if
the Fortress nominees receive a majority of the voting shares cast in the
election of Directors, Ronn K. Lytle, the current Chairman of the Board and
Chief Executive Officer ("CEO") will resign and Wesley R. Edens, Fortress'
chairman and CEO will be appointed Chairman and CEO of the Company. Mr. Lytle
will remain on the Board and will be appointed Vice Chairman.
Should the stockholders not approve the Fortress nominees, the Company and
Fortress each have the right to cause the Company to repurchase the newly issued
preferred stock at a premium of 3 percent. Should these shares be repurchased,
the Company will incur a non-recurring charge of approximately $2.5 million
representing the repurchase premium plus estimated offering expenses. Should the
Fortress nominees be approved and Mr. Lytle terminate his employment, the
Company will incur a non-recurring severance charge of up to $3.7 million under
the terms of an employment agreement entered into with Mr. Lytle in 1992.
36
<PAGE> 32
CORPORATION MORTGAGE CORPORATION
PROPOSED CHANGE IN INVESTMENT STRATEGY
The Company's current investment strategy of managing a portfolio of
primarily Agency Securities to achieve reasonable investment returns has proven
very difficult in today's environment. Earnings currently depend, in part, on
the difference between the interest received on Agency Securities, and the
interest paid on related short-term borrowings. Because Agency Securities are
considered to have virtually no credit risk as a result of real or implied U.S.
government guarantees, yields earned on such investments are relatively low
compared to more credit-sensitive securities of equal maturity and, therefore,
the resulting spread the Company earns over its borrowing costs can be
relatively modest and the opportunity to profitably finance these investments on
other than a short-term basis is generally limited. Therefore, this current
strategy is relatively sensitive to changes in interest rates, which may result
in earnings volatility and fluctuations in the Company's book value per common
share (see "Effects of Interest Rate Changes").
The Company is considering modifying its investment strategy to replace a
portion of its existing mortgage investments with a diversified portfolio of
credit-sensitive CMBS and residential mortgage-backed securities, most of which
are expected to be "investment grade" at the time of purchase as determined by
national rating agencies. Credit-sensitive mortgage securities generally earn
higher yields than those typically earned on the Company's existing mortgage
assets, due largely to a higher risk of default by the underlying borrowers and,
to a lesser extent, reduced liquidity (see "Risks Associated with
Credit-sensitive Investments"). These types of investments may allow for the
reduction of interest rate risk through the use of longer-term financing that
more closely matches the interest rate adjustment features and expected life of
these investments. As a result, the Company anticipates that it may be able to
improve earnings prospects and provide more stability during periods of interest
rate volatility.
Fortress has advised the Board that its objective in investing in Capstead
and taking an active role in its management is to enhance stockholder value by
modifying the Company's investment strategy as discussed above. Fully
implementing this proposed modification of investment strategy could necessitate
a repositioning of the Company's existing portfolio of mortgage securities,
which could result in the recognition in operating results of a portion of the
losses currently reflected in the Company's balance sheet and book value per
common share.
STOCK REPURCHASES AND BOOK VALUES PER COMMON SHARE
In December 1998 the Company completed a previously authorized repurchase
of 1 million common shares at an average price of $4.10 per share (including
transaction costs). In early January 1999, 85,583 formerly restricted common
shares were repurchased at $4.12 per share from employees in order to assist
them with meeting their federal income tax obligations resulting from the
lapsing of restrictions on stock awards with the December 1998 sale of the
mortgage banking operations. On February 4, 1999 the Board authorized the
repurchase of up to 6 million common shares and up to 2 million Series B shares.
As of December 31, 1999, the Company had repurchased 3,607,500 common shares at
an average price of $4.92 (including transaction costs) and 622,000 Series B
shares at an average price of $11.57 (including transaction costs) pursuant to
this repurchase program. On January 25, 2000 the Company repurchased 11,137,000
common shares at a price of $4.55 per share pursuant to a tender offer that
commenced December 9, 1999 and closed January 14, 2000.
37
<PAGE> 33
CAPSTEAD MORTGAGE CORPORATION
Since the first share repurchases in December 1998 and including the
results of the tender offer, the Company has repurchased 25.7 percent of its
outstanding common shares and 3.6 percent of its outstanding Series B shares. As
the common shares continue to trade at prices below book value, share
repurchases may continue. Upon completion of the tender offer in January 2000
the Company had 45,719,023 common shares outstanding. The following table
reflects book value per common share outstanding at the respective balance sheet
dates before and after adjusting for the tender offer (calculated assuming
redemption of Series A and B shares and conversion of the newly issued Series C
and D shares):
<TABLE>
<CAPTION>
December 31
----------------------
1999 1998
----------------------------------------------------- ----------- ----------
<S> <C> <C>
Actual $5.91 $7.56
Adjusted to reflect tender offer 6.17 --
</TABLE>
The Company's book value per common share declined during 1999 primarily as
a result of unrealized losses in market value of its mortgage assets that are
held as available-for-sale and included in the balance sheet as a component of
Other comprehensive income (loss). The market value of the Company's mortgage
assets will continue to fluctuate with changes in interest rates, and such
changes will largely be reflected in book value per common share. Given the
Company's current borrowing capacity, the Company has the ability to hold
mortgage assets for the foreseeable future; however, implementation of the
proposed investment strategy, as discussed above, could necessitate the
recognition in operating results of a portion of these losses.
UTILIZATION OF CAPITAL AND LIQUIDITY
The following table summarizes the Company's utilization of capital and
potential liquidity as of December 31, 1999 (in thousands):
<TABLE>
<CAPTION>
Capital
Assets Borrowings Employed Liquidity
----------- ------------ ---------- -----------
<S> <C> <C> <C> <C>
*
Agency Securities:
FNMA/FHLMC:
Fixed-rate $1,009,577 $ 965,095 $ 44,482 $ 19,321
Medium-term 1,103,704 1,035,923 67,781 34,670
ARMs:
LIBOR/CMT 935,291 734,234 201,057 172,998
COFI 237,721 164,308 73,413 66,282
GNMA ARMs 1,936,032 1,799,033 136,999 78,918
---------- ---------- -------- --------
5,222,325 4,698,593 523,732 372,189
Non-agency Securities 127,059 124,361 2,698 (2,441)
CMBS -- adjustable-rate 59,330 49,438 9,892 4
CMO collateral and investments 3,318,886 3,289,584 29,302 --
---------- ---------- -------- --------
$8,727,600 $8,161,976 565,624 369,752
========== ==========
Other assets, net of other liabilities 48,766 28,488**
-------- --------
$614,390 $398,240
======== ========
</TABLE>
* Based on maximum borrowings available under existing uncommitted
repurchase arrangements considering the fair value of related
collateral as of December 31, 1999 (see "Liquidity and Capital
Resources").
** Represents unrestricted cash and cash equivalents (see NOTE 2 to the
1999 consolidated financial statements).
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<PAGE> 34
CAPSTEAD MORTGAGE CORPORATION
Liquidity, which is defined as surplus capital available for the support
and acquisition of mortgage assets and other investments or activities,
fluctuates with, among other things, the size and fair value of the Company's
mortgage asset portfolios. Since December 31, 1998 stock repurchases,
acquisitions of mortgage assets and a decline in fair value of the Company's
portfolios as a result of higher interest rates have led to a decline in the
Company's liquidity of approximately $137 million. However, liquidity at
year-end remains substantial affording the Company the ability to maintain its
mortgage asset portfolios at current levels for the foreseeable future and to
make additional investments and share repurchases (see "Financial Condition --
Proposed Change in Investment Strategy").
RESULTS OF OPERATIONS
Comparative net operating results by source (interest income or fee
revenues, net of related interest expense and, for CMO administration and the
mortgage banking operations sold in 1998, related direct and indirect operating
expenses) were as follows (in thousands, except per share amounts):
<TABLE>
<CAPTION>
Year Ended December 31
--------------------------------------------
1999 1998 1997
--------- ---------- ---------
<S> <C> <C> <C>
Agency and U.S. Treasury Securities $52,514 $ 12,754 $ 31,892
Non-agency Securities 8,043 4,947 5,867
CMBS -- adjustable-rate 37 -- --
CMO collateral and investments (2,382) (10,078) 40,213
Mortgage banking operations -- 11,821 59,422
CMO administration and other 4,083 4,598 4,000
------- ---------- ---------
Contribution to income 62,295 24,042 141,394
Gain (loss) on sale of mortgage assets and
related derivative financial instruments 1,738 (245,261) 27,737
Impairment on CMO investments -- (4,051) --
Other operating expense (6,124) (9,494) (9,205)
------- ---------- ---------
Net income (loss) $57,909 $ (234,764) $ 159,926
======= ========== =========
Net income (loss) per common share:
Basic $0.61 $(4.22) $2.62
Diluted 0.60 (4.22) 2.35
</TABLE>
1999 COMPARED TO 1998
Operating results for the year ended December 31, 1999 were substantially
improved over 1998 results. Liquidity from restructuring the Company's mortgage
asset portfolios and from the December 1998 sale of the mortgage banking
operations has been employed to reduce borrowings, which has benefited net
margins on the Company's mortgage asset portfolios. Margins also benefited from
first quarter 1999 acquisitions of Agency Securities, slower prepayments and,
earlier in 1999, lower borrowing rates. In 1998 the Company incurred losses from
restructuring its mortgage asset portfolios. Also in 1998, the Company recorded
impairment charges on mortgage servicing and CMO investments and write-offs of
purchase premiums and CMO bond discounts attributable to high levels of
prepayments and the expectation at that time that such prepayment levels would
continue.
The earning capacity of the Company's mortgage asset portfolios is largely
dependent on the overall size and composition of the portfolios, the
relationship between short- and long-
39
<PAGE> 35
CAPSTEAD MORTGAGE CORPORATION
term interest rates (the "yield curve") and the extent the Company continues to
invest its liquidity in these portfolios. The Company is considering modifying
its investment strategy to replace a portion of its existing mortgage
investments with a diversified portfolio of credit-sensitive mortgage securities
with the goal of reducing the Company's exposure to interest rate risk (see
"Financial Condition - Proposed Change in Investment Strategy").
Although yields on the Company's ARM securities are expected to improve in
future quarters as interest rates on underlying mortgage loans reset to levels
more reflective of the current interest rate environment, first quarter 2000
earnings are expected to decline because of higher borrowing costs. If
short-term borrowing rates continue to rise, improving mortgage asset yields
over the next 12 months may not fully keep pace and net interest margins would
likely decline (see "Effects of Interest Rate Changes").
Agency Securities contributed more to operating results during 1999 than
Agency and U.S. Treasury Securities contributed during 1998 due primarily to
having employed significantly more capital to this portfolio which lowered
borrowing costs. In addition, during most of 1999, the Company enjoyed improved
financing spreads over those achieved in 1998. On average, the Company employed
$463 million of its capital to this portfolio during 1999 compared to only $108
million in 1998. Yields for this portfolio were 5.81 percent during 1999
compared to 5.77 percent in 1998, while borrowing rates, although significantly
higher by year-end, averaged 5.16 percent during 1999 compared to 5.54 percent
in 1998. Yields in 1999 have benefited from lower prepayments and changes in
portfolio mix including the sale of relatively low-yielding U.S. Treasury notes
held in 1998. In addition, during 1998 rapidly declining mortgage interest
rates, particularly late in the third quarter, significantly increased
prepayments and prepayment risk resulting in purchase premium amortization
adjustments, which depressed yields. For further discussion on investment
yields, see "Financial Condition - Mortgage Securities and Other Investments"
and "Effects of Interest Rate Changes."
Non-agency Securities contributed more to operating results during 1999
despite a lower average outstanding portfolio because the Company funded this
portfolio entirely with its equity for most of the year. The average outstanding
portfolio was $120 million during 1999, compared to $496 million in 1998 during
which time significantly less capital was employed supporting this portfolio.
Average yields for this portfolio (calculated including mortgage insurance
costs) were 8.06 percent during 1999, compared to 6.79 percent in 1998.
CMO collateral and investments operating results during 1999 were improved
over 1998 results primarily because of significantly lower prepayments in 1999.
In 1998, rapidly declining mortgage interest rates, particularly late in the
third quarter, significantly increased prepayments and prepayment risk resulting
in the third quarter 1998 write-off of $15.7 million of CMO bond discounts and
an impairment charge of $4.1 million to write down to fair value remaining
investments in interest-only securities. The disposition of a $1.0 billion
interest-only mortgage securities portfolio in June 1998, subsequent sales of
remaining purchased interest-only mortgage securities and redemptions of CMOs
have significantly diminished the earning capacity of this portfolio. Without
growth of this portfolio either through the issuance of CMOs in which the
Company retains residual interests, or the acquisition of other CMO investments,
it is likely this portfolio will not provide a positive return on capital
employed in future periods.
The mortgage banking operations were sold in December 1998. At December 31,
1998 the Company had established an accrual of over $23.2 million for contract
settlement
40
<PAGE> 36
CAPSTEAD MORTGAGE CORPORATION
provisions and anticipated costs associated with exiting the mortgage banking
operations. During 1999 the Company settled $21.2 million of this liability
including a $16 million prepayment protection settlement payment and $3.9
million in pricing adjustments on mortgage servicing rights acquisition
agreements assumed by the buyer.
Operating expenses during 1999 were less than in 1998 reflecting lower
costs of operating only the mortgage investment business after the December 1998
sale of the mortgage banking operations.
Gains recorded in 1999 relate primarily to the first quarter sale of
remaining purchased interest-only mortgage securities held as CMO investments.
Losses recorded in 1998 reflect sales of interest-only mortgage securities and
related derivative financial instruments ("Derivatives") as well as other
mortgage assets as part of the restructuring of the Company's mortgage asset
portfolios begun in June 1998 in response to deteriorating conditions in the
mortgage finance industry experienced at that time.
1998 COMPARED TO 1997
Operating results for the year ended December 31, 1998 reflect the impact
on the Company of the unfavorable interest rate environment and market
conditions experienced in 1998 and steps taken by the Company in response
including reducing its mortgage asset portfolios and culminating in the sale of
the mortgage banking operations in December 1998 for a gain of $2.9 million. In
reducing its mortgage asset portfolios, the Company incurred losses of $245.3
million. Net interest margins on the Company's mortgage asset portfolios were
dramatically reduced by the effects of high prepayments which reduced yields on
mortgage assets and declining earning capacity due to reduced holdings. Mortgage
banking results also reflect the effects of high prepayments through higher
mortgage servicing amortization expenses and impairment charges that were not
totally offset by this operation's risk management strategies and limited
mortgage production capacity.
Agency Securities contributed less to operating results during 1998 than in
1997 due primarily to a 38-basis point decrease in financing spreads. The
average outstanding portfolio peaked at $6.5 billion in May 1998 before being
reduced by asset sales and runoff to an average of $2.3 billion in December
1998. Average yields for this portfolio were 5.77 percent during 1998 compared
to 6.18 percent during 1997, while average borrowing rates were slightly lower
at 5.54 percent during 1998 compared to 5.57 percent during 1997. Lower yields
reflect increased amortization of purchase premiums and investments in
relatively low coupon 10-year U.S. Treasury notes. Additionally, lower 6-month
LIBOR and 1-year U.S. Treasury rates contributed to lower yields on ARM
securities.
Non-agency Securities contributed less to operating results during 1998
than in 1997 due primarily to a 22-basis point decrease in financing spreads.
The average outstanding portfolio peaked at $705 million in March 1998 before
being reduced by runoff, sales and a $345.4 million CMO issuance. Average yields
for this portfolio were 6.79 percent during 1998 compared to 6.96 percent during
1997, while average borrowing rates were marginally higher at 5.80 percent
during 1998 compared to 5.75 percent during 1997.
CMO investments contributed substantially less to operating results in 1998
than in 1997 primarily because of the disposition of a $1.0 billion portfolio of
Agency Trust interest-only mortgage securities in June 1998, which significantly
diminished the earning capacity of this portfolio. With an increase in
expectations for future mortgage prepayments, the Company wrote off a
significant portion of remaining CMO investments through CMO bond discount
41
<PAGE> 37
CAPSTEAD MORTGAGE CORPORATION
amortization adjustments aggregating $15.7 million and recorded a $4.1 million
other-than-temporary impairment charge to write down remaining investments in
interest-only mortgage securities to fair value. Average yields for this
portfolio declined to 6.32 percent during 1998 from 10.24 percent during 1997.
Yields were negatively impacted by the downsizing of this portfolio and the
effects of high prepayments.
Mortgage banking revenues increased to $206.1 million in 1998 compared to
$172.9 million in 1997 due to growth of the new mortgage production operation,
higher earnings on temporarily-held cash balances and the $2.9 million gain on
sale of this operation. Amortization expenses of $95.2 million and impairment
charges of $224.7 million recorded in 1998 reflect the effects of high
prepayments (including the prospect of continued high prepayments) on the value
of the mortgage servicing portfolio. These impairment charges were partially
offset by gains of $173.4 million on the disposition of a portfolio of U.S.
Treasury-based financial investments held to protect against declines in the
value of the mortgage servicing portfolio.
Operating expenses during 1998 were comparable to 1997 in total. Higher
general and administrative costs and lower allocations of costs to the mortgage
banking operations were all but offset by lower compensation-related accruals.
Excluding a $251.9 million loss on the sale of Agency Trust interest-only
mortgage securities (net of related gains on Derivatives), the Company recorded
a net gain of $2.3 million on the disposition of $3.8 billion of mortgage
assets. In addition, the Company earned $3.8 million in 1998 from a strategy of
writing call options on a portion of the Company's fixed-rate securities. During
1997 the Company sold $2.0 billion of mortgage assets for gains totaling $27.0
million. Derivatives not designated as hedges contributed $708,000 to operating
results during 1997.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of funds include borrowings under repurchase
arrangements, monthly principal and interest payments on mortgage securities and
other investments, excess cash flows on CMO collateral and investments and
proceeds from sales of mortgage assets (see "Financial Condition -- Utilization
of Capital and Liquidity"). The Company currently believes that these funds are
sufficient for the acquisition of mortgage assets, repayments on borrowings, the
payment of cash dividends as required for Capstead's continued qualification as
a Real Estate Investment Trust ("REIT") and common and preferred stock
repurchases as described below. It is the Company's policy to remain strongly
capitalized and conservatively leveraged.
Borrowings under repurchase arrangements secured by Agency Securities and
Non-agency Securities generally have maturities of less than 31 days, although
in recognition of the potential for greater than normal mortgage finance market
liquidity constraints over this year-end, the Company extended the terms of a
portion of its borrowings up to 4 months beyond year-end. The Company has
uncommitted repurchase facilities with investment banking firms to finance these
mortgage assets, subject to certain conditions. Interest rates on borrowings
under these facilities are generally based on overnight to 30-day London
Interbank Offered Rate ("LIBOR") rates. The terms and conditions of these
arrangements, including interest rates, are negotiated on a
transaction-by-transaction basis. Amounts available to be borrowed under these
arrangements are dependent upon the fair value of the
42
<PAGE> 38
CAPSTEAD MORTGAGE CORPORATION
securities pledged as collateral, which fluctuates with changes in interest
rates and the securities' credit quality.
Borrowings under repurchase arrangements secured by recent purchases of
adjustable-rate CMBS more closely match the interest rate adjustment features
and expected life of these investments such that the Company anticipates it can
earn more consistent net interest spreads on these investments and, as a result,
experience less interest rate volatility than experienced with the Company's
existing mortgage investments. Should the Company make significant additional
investments in credit-sensitive mortgage securities, it is anticipated that the
Company will attempt to lessen interest rate volatility in a similar fashion or
through the use Derivatives such as interest rate swaps (see "Effects of
Interest Rate Changes" and "Risks Associated with Credit-sensitive
Investments").
In February 1999 the Company's Board of Directors authorized the repurchase
of up to 6 million common shares and up to 2 million Series B shares. As of
December 31, 1999, 2.4 million common and 1.4 million Series B shares remained
available for repurchase under this program. In January 2000 the Company
completed a tender offer for 11.1 million common shares at a cash price of $4.55
per share. The Company may continue to repurchase shares in open market
transactions from time to time subject to the price of its securities and
alternative investment opportunities.
EFFECTS OF INTEREST RATE CHANGES
INTEREST RATE SENSITIVITY ON OPERATING RESULTS
The Company performs earnings sensitivity analysis using an income
simulation model to estimate the effects that specific interest rate changes
will have on future earnings. All mortgage assets and Derivatives held, if any,
are included in this analysis. In addition, the sensitivity of CMO
administration fee income to market interest rate levels is included as well.
The model incorporates management assumptions regarding the level of prepayments
on mortgage assets for a given level of market rate changes using industry
estimates of prepayment speeds for various coupon segments. These assumptions
are developed through a combination of historical analysis and future expected
pricing behavior. Primarily because the Company significantly increased its
holdings of Agency Securities early in 1999, earnings are more sensitive to
changes in interest rates at December 31, 1999 than at December 31, 1998, as
indicated in the following table:
<TABLE>
<CAPTION>
Immediate Change In:
(rates in basis points, dollars in thousands)
--------------------------------------------------------
<S> <C> <C> <C> <C> <C>
30-day LIBOR rate Down 100 Down 100 Flat Up 100
10-year U.S. Treasury rate Down 100 Flat Up 100 Up 100
2000 Projected 12-month earnings change* $31,160 $36,190 $5,044 $(37,821)
1999 Projected 12-month earnings change* (424) 12,757 8,065 (4,775)
</TABLE>
* Note that the impact of actual or planned acquisitions of mortgage
assets subsequent to the indicated year-end (beyond acquisitions
necessary to replace runoff) and potential new business activities (see
"Financial Condition -- Proposed Change to Investment Strategy") were
not factored into the simulation model for purposes of this disclosure.
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<PAGE> 39
CAPSTEAD MORTGAGE CORPORATION
Income simulation modeling is a primary tool used to assess the direction
and magnitude of changes in net margins on mortgage assets resulting from
changes in interest rates. Key assumptions in the model include prepayment rates
on mortgage assets, changes in market conditions, and management's capital
plans. These assumptions are inherently uncertain and, as a result, the model
cannot precisely estimate net margins or precisely predict the impact of higher
or lower interest rates on net margins. Actual results will differ from
simulated results due to timing, magnitude and frequency of interest rate
changes and other changes in market conditions, management strategies and other
factors.
GENERAL DISCUSSION OF EFFECTS OF INTEREST RATE CHANGES
Changes in interest rates may impact the Company's earnings in various
ways. The Company's earnings currently depend, in part, on the difference
between the interest received on mortgage securities and other investments, and
the interest paid on related short-term borrowings. The resulting spread may be
reduced or even turn negative in a rising short-term interest rate environment.
Because a substantial portion of the Company's mortgage investments are ARM
mortgage securities, the risk of rising short-term interest rates is generally
offset to some extent by increases in the rates of interest earned on the
underlying ARM loans, which reset periodically based on underlying indices
(generally 6-month LIBOR and 1-year U.S. Treasury rates). Since ARM loans
generally limit the amount of such increases during any single interest rate
adjustment period and over the life of the loan, interest rates on borrowings
can rise to levels that may exceed the interest rates on the underlying loans
contributing to lower or even negative financing spreads. At other times, as
seen in 1998, declines in these indices may be greater than declines in the
Company's borrowing rates which are generally based on 30-day LIBOR,
contributing to lower or even negative financing spreads. The Company may invest
in Derivatives from time to time as a hedge against rising interest rates on a
portion of its short-term borrowings. At December 31, 1999 the Company did not
own any Derivatives as a hedge against rising interest rates.
Another effect of changes in interest rates is that as long-term interest
rates decrease the rate of principal prepayments on mortgage loans underlying
mortgage investments generally increases. To the extent the proceeds of
prepayments on mortgage investments cannot be reinvested at a rate of interest
at least equal to the rate previously earned on such investments, earnings may
be adversely affected. As seen in 1998 prolonged periods of high prepayments can
significantly reduce the expected life of mortgage investments; therefore, the
actual yields realized can be lower due to faster amortization of purchase
premiums. In addition, the rates of interest earned on ARM investments generally
will decline during periods of falling short-term interest rates as the
underlying ARM loans reset at lower rates.
Changes in interest rates also impact earnings recognized from CMO
investments, which have consisted primarily of interest-only mortgage securities
and fixed-rate CMO residuals (see "Financial Condition"). The amount of income
that may be generated from interest-only mortgage securities is dependent upon
the rate of principal prepayments on the underlying mortgage collateral. If
mortgage interest rates fall significantly below interest rates on the
collateral, principal prepayments may increase, reducing or even turning
negative the overall return on these investments. As seen in 1998 sustained
periods of high prepayments can result in losses. Conversely, if mortgage
interest rates rise, interest-only mortgage securities tend to perform favorably
because underlying mortgage loans will generally prepay at slower
44
<PAGE> 40
CAPSTEAD MORTGAGE CORPORATION
rates, thereby increasing overall returns. The Company sold its investments in
interest-only mortgage securities in connection with the 1998 restructuring of
its mortgage asset portfolios
CMO residuals behave similarly to interest-only mortgage securities. As
seen in 1998 if mortgage interest rates fall, prepayments on the underlying
mortgage loans generally will be higher, thereby reducing or even turning
negative the overall returns on these investments. This is due primarily to the
acceleration of the amortization of bond discounts as bond classes are repaid
more rapidly than originally anticipated. Conversely, if mortgage interest rates
rise significantly above interest rates on the collateral, principal prepayments
will typically diminish, improving the overall return on an investment in a
fixed-rate CMO residual because of an increase in time over which the Company
receives the larger positive interest spread.
The Company periodically sells mortgage assets, which may increase income
volatility because of the recognition of transactional gains or losses. Such
sales may become attractive as values of mortgage assets fluctuate with changes
in interest rates. At other times, such as in 1998, it may become prudent to
significantly downsize the mortgage asset portfolios to mitigate exposure to
further declines in mortgage interest rates or, as is currently being
considered, to shift the Company's investment focus to credit-sensitive mortgage
assets (see "Financial Condition -- Proposed Change in Investment Strategy").
RISKS ASSOCIATED WITH CREDIT-SENSITIVE INVESTMENTS
CMBS are generally viewed as exposing an investor to greater risk of loss
than residential mortgage-backed securities since such securities are typically
secured by larger loans to fewer obligors than residential mortgage-backed
securities. Commercial property values and net operating income are subject to
volatility, and net operating income may be sufficient or insufficient to cover
debt service on the related mortgage loan at any given time. The repayment of
loans secured by income-producing properties is typically dependent upon the
successful operation of the related real estate project and the ability of the
applicable property to produce net operating income rather than upon the
liquidation value of the underlying real estate. Even when the current net
operating income is sufficient to cover debt service, there can be no assurance
that this will continue to be the case in the future.
Additionally, commercial properties may not readily be convertible to
alternative uses if such properties were to become unprofitable due to
competition, age of improvements, decreased demand, regulatory changes or other
factors. The conversion of commercial properties to alternate uses generally
requires substantial capital expenditures, which may or may not be available.
The availability of credit for commercial mortgage loans will be
significantly dependent upon economic conditions in the markets where such
properties are located, as well as the willingness and ability of lenders to
make such loans. The availability of funds in the credit markets fluctuates and
there can be no assurance that the availability of such funds will increase
above, or will not contract below current levels. In addition, the availability
of similar commercial properties, and the competition for available credit, may
affect the ability of potential purchasers to obtain financing for the
acquisition of properties. This could effect the repayment of commercial
mortgages pledged to secure CMBS.
45
<PAGE> 41
CAPSTEAD MORTGAGE CORPORATION
Credit-sensitive residential mortgage-backed securities differ from CMBS in
several important ways, yet can still carry substantial credit risk. Residential
mortgage securities typically are secured by smaller loans to more obligors than
CMBS, thus spreading the risk of mortgagor default. However, most of the
mortgages supporting these securities are made to homeowners that do not qualify
for Agency loan programs for reasons including loan size, financial condition,
or work or credit history that may be indicative of higher risk of default than
loans qualifying for such programs. As with CMBS, in instances of default the
Company may incur losses if the proceeds from the sale of the underlying
collateral less related foreclosure costs, are less than the unpaid principal
balance of the mortgage loan. However, with residential mortgage-backed
securities, this risk may be mitigated by various forms of credit enhancements
including, but not limited to, primary mortgage insurance.
Through the process of securitizing both commercial and residential
mortgages, credit risk can be heightened or minimized. Senior classes in
multi-class securitizations generally have first priority over cash flows from a
pool of mortgages and, as a result, carry the least risk, highest investment
ratings and the lowest yields. Typically a securitization will also have
mezzanine classes and subordinated classes. Mezzanine classes will generally
have somewhat lower credit ratings and may have average lives that are longer
than the senior classes. Subordinate classes are junior in the right to receive
cash flow from the underlying mortgages, thus providing credit enhancement to
the senior and mezzanine classes. As a result, subordinated securities will have
lower credit ratings because of the elevated risk of credit loss inherent in
these securities.
The availability of capital from external sources to finance investments in
credit-sensitive CMBS and residential mortgage-backed securities that are not
financed to maturity at acquisition may be diminished during periods of mortgage
finance market illiquidity, such as was experienced in 1998. Additionally, if
market conditions deteriorate resulting in substantial declines in value of
these securities, sufficient capital may not be available to support the
continued ownership of such investments, requiring these securities to be sold
at a loss.
There can be no assurance as to what extent, if any, beyond the initial
purchases of CMBS described previously, this proposed strategy to invest in CMBS
or other credit-sensitive securities will be implemented and, if implemented,
whether or not it will be successful in meeting the Company's goals. In
addition, there can be no assurance that the Company will be able to
successfully assess and monitor these risks.
OTHER
IMPACT OF THE YEAR 2000
The Company took the necessary steps to ensure that its software systems
and applications would not fail or create erroneous results by or at December
31, 1999 ("Year 2000 compliant"). The Company also took steps to ensure that the
vendors it utilizes and institutions that it interfaces with had also taken the
necessary steps to become Year 2000 compliant. The financial costs of becoming
Year 2000 compliant, including the construction a new computer network did not
exceed $600,000. The Company experienced no material instances of Year 2000
compliance failures.
46
<PAGE> 42
CAPSTEAD MORTGAGE CORPORATION
FORWARD LOOKING STATEMENTS
This document contains "forward-looking statements" (within the meaning of
the Private Securities Litigation Reform Act of 1995) that inherently involve
risks and uncertainties. The Company's actual results and liquidity can differ
materially from those anticipated in these forward-looking statements because of
changes in the level and composition of the Company's investments and unforeseen
factors. These factors may include, but are not limited to, changes in general
economic conditions, the availability of suitable investments, fluctuations in
and market expectations for fluctuations in interest rates and levels of
mortgage prepayments, deterioration in credit quality and ratings, the
effectiveness of risk management strategies, the impact of leverage, liquidity
of secondary markets and credit markets, increases in costs and other general
competitive factors.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998 the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"). SFAS 133 establishes accounting and
reporting standards for Derivatives and hedging activities. It requires that an
entity recognizes all Derivatives as either assets or liabilities in the
statement of financial position and measures those instruments at fair value. If
certain conditions are met, a Derivative may be specifically designated as (i) a
hedge of the exposure to changes in the fair value of a recognized asset or
liability or an unrecognized firm commitment; (ii) a hedge of the exposure to
variable cash flows of a forecasted transaction; or (iii) in certain
circumstances, a hedge of a foreign currency exposure. This statement is
effective for the Company's fiscal year ending December 31, 2001. The adoption
of SFAS 133 is not expected to have a material impact on the financial position
or results of operations of the Company.
47
<PAGE> 1
EXHIBIT 21
LIST OF SUBSIDIARIES OF
CAPSTEAD MORTGAGE CORPORATION
At December 31, 1999 the subsidiaries of Capstead Mortgage Corporation were as
follows:
<TABLE>
<CAPTION>
STATE OF
DOMICILE
<S> <C>
PARENT COMPANY
SUBSIDIARY
Capstead Mortgage Corporation ("CMC")......................................................... Maryland
Capstead Advisers, Inc..................................................................... Nevada
Capstead Capital Corporation............................................................... Delaware
Capstead Select Corporation................................................................ Delaware
Capstead Securities Corporation I.......................................................... Delaware
Capstead Securities Corporation II......................................................... Delaware
Capstead Securities Corporation III........................................................ Delaware
Capstead Securities Corporation IV......................................................... Delaware
CMC Securities Corporation I............................................................... Nevada
CMC Securities Corporation III............................................................. Delaware
CMC Securities Corporation IV.............................................................. Delaware
CMC ARM Securities Corporation............................................................. Delaware
Capstead Mortgage Services Corporation..................................................... Delaware
Capstead Holdings, Inc.(1)................................................................. Delaware
Capstead Inc.(2)........................................................................ Delaware
CMC Securities Corporation II(2)........................................................ Delaware
CMC Investment Partnership(3)................................................................. Texas
</TABLE>
(1) CMC owns all of the issued and outstanding preferred stock.
(2) Capstead Holdings, Inc. owns all the issued and outstanding common
stock.
(3) A general partnership owned by CMC and Capstead Holdings, Inc.
<PAGE> 1
EXHIBIT 23
CONSENT OF ERNST & YOUNG LLP
INDEPENDENT AUDITORS
We consent to the incorporation by reference in this Annual Report on Form 10-K
of Capstead Mortgage Corporation of our report dated January 27, 2000, included
in the 1999 Annual Report to Stockholders of Capstead Mortgage Corporation. We
also consent to the incorporation by reference in the following registration
statements and the related prospectuses, of our report dated January 27, 2000
with respect to the consolidated financial statements incorporated herein by
reference in the Annual Report on Form 10-K of Capstead Mortgage Corporation:
o Form S-8 (No. 33-40116);
o Form S-8 (No. 33-40117);
o Form S-3 (No. 33-62212);
o Form S-3 (No. 33-52415);
o Form S-8 (No. 33-53555);
o Form S-3 (No. 33-57164);
o Form S-3 (No. 333-03187);
o Form S-8 (No. 333-12719);
o Form S-3 (No. 333-26419);
o Form S-3 (No. 333-26865);
o A pre-effective amendment to Form S-3 (No. 333-26419);
o Form S-8 (No. 333-27215);
o A post-effective amendment to Form S-3 (No. 333-26865); and
o Form S-3 (No. 333-43169).
ERNST & YOUNG LLP
Dallas, Texas
March 13, 2000
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM CAPSTEAD
MORTGAGE CORPORATION ANNUAL REPORT ON FORM 10-K FOR THE PERIOD ENDED DECEMBER
31, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 28,488
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 8,807,039
<CURRENT-LIABILITIES> 4,903,065
<BONDS> 3,289,584
0
191,476
<COMMON> 569
<OTHER-SE> 422,345
<TOTAL-LIABILITY-AND-EQUITY> 8,807,039
<SALES> 0
<TOTAL-REVENUES> 568,980
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 8,138
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 502,933
<INCOME-PRETAX> 57,909
<INCOME-TAX> 0
<INCOME-CONTINUING> 57,909
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 57,909
<EPS-BASIC> 0.61
<EPS-DILUTED> 0.60
</TABLE>
